New

Subsection 247(2)

Cases

GlaxoSmithKline Inc. v. The Queen, 2012 DTC 5147 [at 7338], 2012 SCC 52

premium purchase price based on licence

The taxpayer purchased an active pharmaceutical ingredient from an affiliated non-resident corporation ("Adechsa") for approximately five times the amount that was paid by Canadian generic drug manufacturers for that (chemically identical) ingredient. The taxpayer then used the ingredient to produce pills or other delivery mechanisms, and marketed the product under the applicable brand name. The trial judge found that, for the purpose of deducting its ingredient costs, the taxpayer should be deemed under s. 69(2) to have paid the lower generic rate. However, the taxpayer had been licensed by another affiliated non-resident (the "Glaxo Group") to among other things use the drug's brand-name in its marketing, but was required under this licence agreement to buy the active ingredient from Adechsa or another affiliate at the elevated price.

After noting (at para. 47) that an arm's length distributor of the Glaxo Group might well be faced with the same requirement under a licence agreement to purchase from these Glaxo affiliates, Rothstein J. found (at para. 52) that the licence agreement was clearly relevant to determining whether some level of premium pricing under the Adechsa supply agreement still resulted in a price that would have been reasonable in the circumstances if the taxpayer and Adechsa had been dealing at arm's length:

Considering the Licence and Supply agreements together offers a realistic picture of the profits of Glaxo Canada. ... The prices paid by Glaxo Canada to Adechsa were a payment for a bundle of at least some rights and benefits under the Licence Agreement and product under the Supply Agreement.

He also noted (at para. 42) that this approach was consistent with the 1995 OECD Transfer Pricing Guidelines, para. 1.15, which indicated that:

[A] proper application of the arm's length principle requires that regard be had for the 'economically relevant characteristics" of the arm's length and non-arm's length circumstances to ensure they are "sufficiently comparable".

The Court also denied the taxpayer's cross-appeal, which had advanced the position that the Minister's assumptions had been "demolished," so that the Minister's reassessment should be set aside rather than referring the matter back to the Tax Court for determination of a reasonable price in light of the now-established relevance of the licensing agreement. Although a price above the generic rate may have been justified, it did not necessarily follow that a price five times the generic rate was reasonable.

The Queen v. General Electric Capital Canada Inc., 2011 DTC 5011 [at 5558], 2010 FCA 344

interest savings exceeded 1% guarantee fee

The Minister disallowed the deduction by the taxpayer of guarantee fees paid by it to its US parent. The fees were calculated as 1% of the face amount of the commercial paper and other debts of the taxpayer that were guaranteed.

Noel J.A. accepted the submission of the Crown that the determination of an arm's length guarantee fee for purposes of ss. 247(2)(a) and (c) (and for purposes of s. 69(2) for the earlier taxation years in question) should take into account the fact that even without a guarantee, there would have been "implicit support" by the US parent of the taxpayer, i.e., the market would take into account reputational pressures on the US parent to support its subsidiary. It was necessary to take "into account all the circumstances which bear on the price whether they arise from the relationship" between the taxpayer and its non-resident contracting party or otherwise (para. 54). However, even taking into account the implicit support, the interest rate savings to the taxpayer as a result of receiving the guarantee exceeded the guarantee fees, so that the Tax Court had correctly found that amount of the guarantee fees did not exceed the amount that would have been agreed to by parties dealing at arm's length in the same circumstances.

Under Nortel's transfer pricing methodology, the entities performing R&D, including Nortel itself and a UK subsidiary, were entitled to all residual profits after payment of returns to the Nortel subsidiaries that performed sales and distribution functions. The related agreement specified that restructuring costs incurred by each R&D subsidiary were not to be shared.

Following Nortel's insolvency, Newbould J. rejected various submissions made by the administrators of the pension plan for the UK subsidiary respecting transfer pricing, including that this arrangement failed to properly compensate the UK subsidiary for its restructuring costs. He accepted the monitor's position that "Chapter 9 of the OECD Guidelines explicitly frames the issue of restructuring costs and benefits as a question of ex ante risk allocation by way of an intercompany contract, rather than an ex post examination of who should bear the realization of a risk (i.e., restructuring costs)." Furthermore, the approach of the claimants' expert that "one starts with the economic substance and then looks to see if the legal form follows the economic substance" was "the opposite of what the OECD Guidelines call for."

See summary under Treaties – Art. 9.

AgraCity Ltd. v. The Queen, Docket: 2014-1537 (IT) G

factual allegation that foreign affiliate did nothing was fatal to ss. 247(2)(a) and (c) pleadings but not ss. 247(2)(b) and (d)

In her Reply, the Minister alleged that a Barbados corporation ("NewAgco") which did not deal at arm's length with the taxpayer, took over a business of selling a product ("ClearOut") to Canadian farmers, and that NewAgco agreed to pay services fees to the taxpayer amounting to approximately $1 million for its 2007 and 2008 fiscal periods as contrasted to net profits of Barbados from sales of ClearOut for those years of $2.4 million and $3.6 million.

C. Miller J found (at para. 16) that if he took the Minister's pleadings "that NewAgco had no role in selling ClearOut as true," there was "no basis upon which the Minister can successfully apply section 247(2)(a)." Accordingly, he struck the Minister's pleading, that the terms of the agreement between the taxpayer and NewAgco differed from arm's length terms. However, he did not strike pleading directed at ss. 247(2)(b) and (d) as that provision:

...does not limit the Minister to a comparison of a particular transaction (the service agreement) between the non arm's length parties at issue and fictional arm's length parties, but allows the much broader view of the series of transactions and the recharacterization into what would or would not arm's length parties have done (para. 20).

He noted (at para. 17) that, if supporting evidence emerged at trial, the Minister could advance ss. 247(2)(a) and (c) as alternative arguments.

McKesson Canada Corp. v. The Queen, 2014 DTC 1197 [at 3749], 2014 TCC 266

highly discounted receivables purchased by non-resident affiliate were not "pig in a poke"

Boyle J, after finding in McKesson that the taxpayer had been selling its trade receivable to its immediate Luxembourg parent (MIH) at discounts which were excessive from a transfer pricing perspective, recused himself from consideration of residual issues (respecting costs and the disposition of sealed documents) on the ground that he might no longer be considered to be impartial, as McKesson Canada, in its factum filed with the Federal Court of Appeal, had alleged that he was "untruthful and deceitful" in his reasons, stated "clear untruths" about him and alleged that he was not impartial (numerous paras. beginning at 4).

His explanation of the untruths included quotes from the extensive exchanges from the bench at trial:

There, he expressed concern about the taxpayer, which began with a cost of funds of nearing 5%, quadrupling this cost on the basis of laying off risk to MIH (para. 54).
The taxpayer's approach, that (ignoring MIH's knowledge and control as parent) MIH was "buying a pig in a poke," so that it was taking on a lot of risk, would mean that "virtually every Canadian subsidiary…[could] be re-pricing to 5 year junk rates" (para. 65).
However, in his trial reasons, it had not been necessary to rely on the likely law that this parent-subsiadary relationship could be taken into account as under the terms of the receivables purchase agreement, MIH had an out once the collection performance began to deteriorate (para. 19).

Marzen Artistic Aluminum v. The Queen, 2014 DTC 1145 [at 3433], 2014 TCC 194

separate entity approach endorsed

In 2000 and 2001 the Canadian-resident taxpayer, which manufactured windows in British Columbia, paid Cdn.$4.2M and Cdn.$7.8M in fees under a "Marketing Services and Sales Agreement" ("MSSA") to a wholly owned Barbados subsidiary ("SII"), including a "bonus" in the case of 2001 of U.S.$2M. SII in turn paid US$1.4M (Cdn.$2.1M) and US$1.8M (Cdn.$2.8M) to a Washington subsidiary of the taxpayer ("SWI") for the provision of SWI's employees to perform services for SII at cost plus 10%. SII, which had minimal expenses other than the fees paid to SWI, declared exempt dividends to the taxpayer which essentially were equal to its earnings. The taxpayer had approximately nil operating income after deduction of the "marketing fees" so that these dividends represented essentially all of its profits. SWI, which sold windows principally in California, purchased the windows from the taxpayer at a cost equal to its selling price so that it as well had no significant operating profit.

The Minister reassessed the taxpayer under the transfer pricing rules to limit the taxpayer's deduction of MSSA fees to the amount of the SWI "secondment fees," and imposed s. 247(3) penalties.

Sheridan J found that as SII had insubstantial assets and no personnel other than its managing director, who lacked the marketing experience and know-how of the key managers of SWI and the taxpayer, SII provided nothing of value to the taxpayer beyond the services provided by SWI's employees, and the relatively minor value of the services provided by its managing director (for which she adjusted on the basis that the amounts paid to him were the relevant comparable uncontrolled price). Although SII's managing director may have provided useful advice, such as suggesting moving into the California market, he did so in his personal capacity rather than through SII. In rejecting the approach of the taxpayer's expert, which was to treat SWI and SII as an "amalgam" so that their combined contribution was analysed, Sheridan J found (at para. 191) that the OECD Guidelines (which she found at Para. 208 should be applied in their 1995 rather than 2010 form) instead endorsed a separate entity approach.

McKesson Canada Corp. v. The Queen, 2014 DTC 1040 [at 2723], 2013 TCC 404

terms adjusted within framework of transaction chosen by taxpayer

With "the predominant purpose...of...the reduction of its Canadian tax on its profits" (para. 18), the taxpayer, which was an indirect Canadian subsidiary of McKesson Corporation (a U.S. public company), entered into an agreement (the "RSA") for the sale of its trade receivables, as they arose (mostly from sales by it of pharmaceutical products to Canadian drug stores and hospitals), at a discount to its immediate Luxembourg parent ("MIH"). The initial receivable balance sold was $460M. The receivables were required to be sold on a serviced basis (with the taxpayer charging a fixed servicing fee which was not challenged) and on a non-recourse basis (except for the ability of MIH to put them back to the taxpayer for the amount collected by the taxpayer.) All receivables were sold at a fixed discount from their face amount of 2.206% (which worked out to an annualized rate of 27% given an average of 30 days until collection) and the Minister reassessed on the basis that the discount should be 1.013% (corresponding to an annualized effective financing rate of around 12.5%) thereby resulting in an upward transfer pricing adjustment to the taxpayer's 2003 taxation year (the first affected year) of $26.61M together with Part XIII tax on a deemed dividend based on a correlative conferral of a benefit on MIH.

In finding that the taxpayer's evidence did not make out a prima facie case to demolish the assumptions of fact underlying the Minister's choice of a 1.013% discount rate, so that the taxpayer's appeal was dismissed, Boyle J made the following findings and observations:

The appropriate approach under ss. 247(2)(a) and (c) was "to follow the structure of the RSA that the McKesson Group chose to enter into…and consider whether the terms and conditions which affect the Discount Rate pricing differ from what arm's length terms and conditions would be expected to provide" (para. 270) – rather than to look at the pricing that would have applied to a different structure, e.g., a sale of the receivables on a recourse basis, with such recourse secured by a reserve (para. 166).
Contrary to the actual terms, arm's length parties would have reduced the discount rate applied on the initially sold receivables to reflect that they were on average only 16 days away from being collected (paras. 70, 291).
The component of the discount rate to reflect potential bad debt losses should be reduced so as to only reflect the historic loss performance of the taxpayer's receivables pool (of 0.04%) plus a 50% to 100% premium over this (increasing this component to 0.06% to 0.08%) to reflect a risk of this experience deteriorating (paras. 306, 311-312) – rather than using a much higher imputed loss rate based on the proposition that the sales customers did not have bond ratings ("I can not reasonably conclude that a company that does not have a bond rating can be assumed to be hiding a bad implicit rating from the public" (para. 298, see also para. 245).)
Only a modest additional discount (of 0.17% to 0.25%) would be needed to account for a risk that an arm's length purchaser might have to incur additional costs to hire a replacement servicer if a termination event occurred and the taxpayer no longer was suitable (para. 333).
Although it was odd that "the parties to the RSA provided that prompt payment discounts are not treated as deemed receipts but are instead at the purchaser's risk," Boyle J accepted "that arm's length parties might agree to such a term" (para. 334). However, rather than their agreeing to a fixed discount spread to reflect the risk that an increasing number of customers would take prompt-payment discounts (as was done here), they would instead adopt "a three or four month, or annual floating dynamic payment component to the Discount Spread component…to fully capture…the risk of change" (para. 338).
The interest discount should not be increased by an assumed cost of funds that would be associated with MIH financing 100% of the purchase price by issuing junk bonds, as there was no basis to suggest that the taxpayer would be driven to seek receivables financing from a high cost factoring company rather than a major financial player. Adding a modest additional interest discount of 0.0% to 0.08% (reflecting the investment grade credit rating of the US parent) was appropriate (para. 349).
The Court…should consider "notional continued control type rights in appropriate circumstances," as "if these were to be ignored ... companies within wholly controlled corporate groups could enter into skeletal agreements conferring few rights and obligations to the non-resident participant ... all with the view to obtaining a more favourable transfer price..." (para. 132).

Extract from 10K of McKesson Corporation for year ended 31 March 2015

We have received reassessments from the Canada Revenue Agency ("CRA") related to a transfer pricing matter impacting years 2003 through 2010, and have filed Notices of Appeal to the Tax Court of Canada for all of these years. On December 13, 2013, the Tax Court of Canada dismissed our appeal of the 2003 reassessment and we have filed a Notice of Appeal to the Federal Court of Appeal regarding this tax year. After the close of 2015, we reached an agreement in principle with the CRA to settle the transfer pricing matter for years 2003 through 2010. Since the agreement in principle did not occur within 2015, we have not reflected this potential settlement in our 2015 financial statements. We will record the final settlement amount in a subsequent quarter and do not expect it to have a material impact to income tax expense.

Burlington Resources Finance Company v. The Queen, 2013 DTC 1190, 2013 TCC 231

This decision concerned motions to amend or strike pleadings.

The taxpayer, a Nova Scotia unlimited liability company, raised U.S.$3 billion in capital by issuing notes to arm's-length parties. The notes were guaranteed by its US parent ("BRI"). The Minister disallowed the deduction of $82 million in guarantee fees under inter alia ss. 247(2)(a) and (c), but also "invoked" ss. 247(2)(b) and (d).

Hogan J found that it was "manifestly incorrect" for the Minister's Reply to refer to the "consideration for the guarantee fee" rather than "consideration for the guarantee" (para. 29). After noting that the Reply apparently had been framed this way in order to avoid compromising a theory that an arm's length person would have refused to enter into the guarantee agreement, Hogan J stated (at para. 32) that acknowledging the guarantee's existence did not contradict an argument "that an arm's length person would not have entered into the same agreement if placed in the circumstances of the parties."

Although he ordered the Minister to amend her reply, Hogan J further emphasized that doing so did not seriously undermine the potential merit of her case:

It was legitimate for the Minister to question the value of a guarantee to an NSULC from its principal, given that a shareholder of an NSULC is liable for the NSULC's unpaid debts on a winding-up (para. 40).
The mere fact that the guarantee arrangement may have had a bona fide non-tax purpose (i.e. obtain a guarantee to enable the taxpayer to secure financing) was not conclusive as to the primary purpose of the transaction (para. 45).

Alberta Printed Circuits Ltd. v. The Queen, 2011 DTC 1177 [at 967], 2011 TCC 232

internal CUP applied over TNMM

The Canadian taxpayer was in the business of printing custom electronic circuits. Pizzitelli J. found that the taxpayer was not dealing at arm's length with a Barbados corporation from which it received circuit printing set-up services, software, and web site design and maintenance.

Because the taxpayer was actually selling set-up services to third parties in Canada, and was in turn purchasing those services at the same price from the Barbados company, Pizzitelli J. found that the taxpayer had established comparable unrestrained prices between the taxpayer and one external party ("internal CUP") (paras. 185-86). The Minister's valuation method relied on the transactional net margin method ("TNMM"). Because internal CUP trumps TNMM on the hierarchy of pricing methods to be applied under s. 247(2), and the only higher method (external CUP) was not verifiable, the taxpayer's internal CUP comparable prevailed - it had therefore established arm's length prices on the set-up fees, and was entitled to deduct them in full.

The taxpayer's deductions of fees paid for software and web services were denied, as the taxpayer had not met the burden of proving that parties at arm's length would have dealt on those terms.

Ford Motor Co. of Canada, Ltd. v. Ontario Municipal Employees Retirement Board, 2004 DTC 6224 (Ont. Sup. Ct. of J.)

In the context of a determination of what was the fair value of shares held by minority shareholders of a Canadian auto subsidiary ("Ford Canada") at the time of a going-private transaction, Cumming J. found that the U.S. parent ("Ford U.S.") was charging more than a fair price for automobiles sold by it to Ford Canada under a system which gave to Ford U.S. a fixed mark-up over its costs of manufacturing and assembling such vehicles and a pro rata recovery of design costs. He stated (at p. 6256) that:

"No arm's length purchaser would agree to buy vehicles, parts and intangibles ... . at a higher cost than the reasonably anticipated revenue from the sale of those vehicles and parts in the Canadian market ... . The simple reality is that Ford Canada could not pass on all of its increased costs (imposed by the transfer price system) to its dealers because the dealers had to remain competitive in the very competitive Canadian market."

Cumming J. instead found (at p. 6266) that the profit split approach contained in the analysis of one of the experts "provides adjusted results that are more reasonable than the reported results of Ford Canada and Ford U.S."

Safety Boss Limited. v. The Queen, 2000 DTC 1767, Docket: 1999-1429-IT-G (TCC)

Because of the reputation and the prior personal contacts of the taxpayer's shareholder ("Miller") with officials of the Kuwait Oil Company, in February 28, 1991 the Kuwaiti government entered into an agreement with the taxpayer for it to extinguish oil well fires which were expected to be ignited by the retreating Iraqi troops. On June 28, 1991 a Bermuda company ("SBIL") was incorporated and capitalized by the taxpayer and on August 2, 1991 Miller departed Canada and became a Bermuda resident. On August 30, 1991 the taxpayer declared (and subsequently paid) a $3 million bonus to Miller. Miller included 155/185 of this amount in his Canadian income based on the proportion of the days between February 28 and August 30 when he was resident in Canada. Effective September 1, 1991 the taxpayer commenced paying SBIL a monthly services fee of $800,000 for the duration of the work in Kuwait. The Minister disallowed pursuant to s. 69(2) the deduction of the fees paid to SBIL and of the portion of the bonus attributable to the period when Miller was not resident in Canada, in each case, to the extent that the amount exceeded $2,250 per day while Miller was in Kuwait and $750 per day when he was not ($2,250 being the $1,500 per day paid to another employee plus an additional $750). The Minister also assessed under Part XIII tax on the basis that the disallowed amount represented a benefit conferred on Miller.

In allowing the taxpayer's appeal, Bowman TCJ. noted that it was Miller who predominantly contributed to the taxpayer's profit and that Miller had accepted no or reduced remuneration in the previous lean years to keep the taxpayer afloat. After comparing the wording of ss.69(2) and 67, he stated (at p. 1770) that "if there is a difference between the concepts in the two provisions it is not readily apparent".

Administrative Policy

1 September 2015 Memorandum 2013-0507381I7 - Transfer pricing adjustments and gross revenue

[s. 247(2) increases to gross revenues]

CRA considered that an upward adjustment to a Canadian resident’s sales proceeds – but not a downward adjustment to its purchase price for goods – increased its gross revenue for provincial income allocation purposes. See summary under Reg. 402(3).

TPM-16 "Role of Multiple Year Data in Transfer Pricing Analyses" 29 January 29 2015

Selecting the most appropriate point in the range

28. When several comparable transactions or results are acceptable, an arm's length range will usually be established by the CRA. In accordance with paragraph 3.60 of the Guidelines, the CRA will not make a transfer pricing adjustment if the price or margin of a transaction is within the arm's length range. If, however, the price or margin falls outside the established range, the CRA will determine the most appropriate point within the range using the most suitable measure of central tendency under the circumstances. Where no further distinction can be made on the basis of comparability, the most appropriate point may usually be determined by using the average.

Conclusion

–permissible use of multi-year data

29. While multiple years of data may be useful to select, reject, or determine the degree of comparability of potentially comparable transactions, transfer prices for a given year should be determined based on the results of a single year of data from each of the comparable transactions. Therefore, taxpayers should not average results over multiple years for the purpose of substantiating their transfer prices in an audit context. The CRA will look at the results for comparable data and apply them on a year-by-year basis.

TPM-15 "Intra-group services and section 247 of the Income Tax Act" 29 January 2015

Direct v. indirect charges

10. … The direct charge method attaches a specific charge to each identifiable service. The indirect charge method involves an allocation of centralized service costs to particular entities using a basis or allocation key designed to reflect the proportionate benefit received.

11. … As long as the indirect charge results in an allocation that is commensurate with the expected benefit, the OECD accepts such indirect charge methods except in cases where the services are a main business activity of the provider and are also provided to third parties, in which case the direct charge method is preferable.

12. The [OECD] Guidelines also specify certain situations where an indirect charge method would likely be appropriate:

where the direct charge method is difficult to apply because the comparative services that the entity provides to third parties are only occasional or marginal (paragraph 7.21);

where the proportionate benefit received by each entity can only be estimated, not precisely quantified (paragraph 7.24); and

where the analysis and record keeping required to separately track or identify the benefit received by each entity is onerous in relation to the activity itself (paragraph 7.24).

Shareholder costs

27. [After largely repeating IC 87-2R, paras. 166-170:] Costs of auditing and fundraising for the acquisition of an interest would not be allowed unless the funds were raised on behalf of another member of the group to acquire a new company. 27

28. ...Sarbanes-Oxley costs…should be reviewed and if the taxpayer can demonstrate that there is a benefit to the taxpayer associated with the charge/expense, it could be allowed as a deduction. …

Allocation of corporate group costs

36. … It may be preferable to implement a multiple allocation basis for intra-group services to better reflect the benefits received. … For example, time spent could be an appropriate allocation basis to allocate costs of the tax services, legal services, data processing, and the usage cost of a corporate jet, while the number of employees may be an appropriate basis on which to allocate the costs of the human resources department. …

Duplicate costs

38. …[C]osts allocated to a Canadian entity in cases where the Canadian entity is self-sufficient are not allowable, but the costs of activities for which the assistance of the foreign entity is necessary or beneficial to the Canadian operations are allowable.

40. …[D]ouble dipping of expenses, is also a concern to the CRA…. Some examples are: Directors' fees and management fees…Royalty payment and management fees…Interest expense and management fees… .

Looking through management fees to underlying non-deductible/withholdable items

45. Where the management fee charged is an arm's length amount, and where the type of management fee contract is normally found in dealings between arm's length parties, it may, where circumstances warrant, be acceptable not to ask for a breakdown of the items included in the management fee.

46. On the other hand, where the type of contract is not usually found in dealings between arm's length parties, auditors may look through the management fee to determine exactly what the Canadian entity is paying for. Under section 247…, if an arm's length party would not pay for the transactions, there should be no reason for the charge to the Canadian entity. In addition, looking through the management fee charged may identify expenses that are not deductible under specific sections of the Income Tax Actor or to which Part XIII withholding tax applies.

Standby charges

50. Stand-by charges for service availability would not be expected in circumstances where:

there is little likelihood that the service will be needed;

there is no real advantage in having the services available; and/or

the services could likely be obtained promptly without a stand-by arrangement.

Services fees mark-ups

70. ... [A]lthough an enterprise providing services at arm's length would typically expect to generate a profit, such a profit element should not be regarded as automatic. A mark-up would not be appropriate in certain transactions… .

71. Furthermore, even where a mark-up or profit element can be supported by reference to comparable transactions at arm's length, auditors must consider whether all of that profit should be attributable to the service provider. In particular, in cases where an activity has been centralized in an MNE to generate cost savings for the participants, it is important to consider whether the participants have fairly shared in any costs savings that should accrue to them as a result of the shared service arrangement. See paragraph 9.156 of Chapter IX of the [OECD] Guidelines… .

Agency services

75. …[I]t will often make more sense to relate the compensation of the purchasing entity to its costs incurred as a facilitator or to the size of the discount it obtains rather than to the value of the goods purchased….

3 October 2014 Memorandum 2014-0532051I7 - Rent and Part XIII Tax

non-commercial arrangement not subject to s. 247

A non-resident individual not carrying on business in Canada leases a Canadian property to a related resident individual at less than fair market value rent What is the incidence of Part XIII tax? The Directorate stated:

[T]he fact that the amount of rent…is below… fair market value would… not…impact the amount subject to withholding tax under paragraph 212(1)(d). … [T]he transfer pricing rules in section 247… would generally not be applied to adjust the amount of rent under the circumstances… .

See summary under s. 212(1)(d).

10 October 2014 APFF Roundtable Q. 26, 2014-0538201C6 F

arm's length transfer price prevails over FMV

On a non-arm's length transfer of capital property by a non-resident in favour of a resident Canadian, whether by donation or disposition, what value should be used in any adjustment to the property's deemed cost? CRA responded (TaxInterpretations translation):

[I]f a non-resident disposes or makes a gift of taxable Canadian property in favour of a person with whom it does not deal at arm's length, the disposition is deemed to be made at FMV in accordance with section 116. On the other hand, in the transfer pricing context, when the conditions for the application of subsection 247(2) are satisfied, the arm's length transfer price is used. … As for FMV, it generally represents the highest price obtainable for a property on a sale in a free and open market between two willing, informed and prudent persons acting independently. In a transfer pricing context where these values are different, subsection 247(8) confirms…that if the transfer price is adjusted pursuant to the application of subsection 247(2), subsections 69(1) and (1.2) are not applicable. Thus, the arm's length transfer price generally would be used… .

15 November 2013 Memorandum 2013-0478621I7 F - Transfer of intangibles - TP adjustments

group sale with Canco not charging for intangibles

Pursuant to a sales agreement between Canco, its immediate non-resident parent (Parent) and the ultimate U.S. parent of Canco (Publico), as vendors, and an arm's length purchaser (Acquireco1), for the sale of Division 1 for a sum of U.S.$XX, Canco disposed of assets of Division 1 to a subsidiary of Acquireco1 for their book value. The Montreal TSO took the view that the Division 1 assets included intangible assets whose value was not reflected in this selling price. Similar transactions occurred for the sale of Division 2 to Acquireco2.

CRA stated (TaxInterpretations translation) in indicating that a higher sale price should be imputed to Canco:

[A]fter consideration of various provisions of the Act, such as section 68 and 69 as well as subsections 14(1), 56(2) and 247(8), it appears to us that the primary adjustments respecting Canco should, where appropriate, be an application of subsection 247(2).

31 October 2012 TPM-14 "2010 Update of the OECD Transfer Pricing Guidelines"

After noting that in the 2010 version of the OECD Transfer Pricing Guidelines "there is no strict hierarchy to be applied to the selection of a transfer pricing method," CRA stated that:

These changes do not firmly de-emphasize the natural hierarchy but they refocus the topic on what is truly relevant – the degree of comparability available under each of the methods and the availability and reliability of the data.

After indicating that the 2010 version of the Guidelines will be applied to all years including for transactions that were completed before the July 22, 2010 release of the revised Guidelines, CRA stated:

Since the revisions are intended to increase clarity in the application of the arm's length principle, the revisions should apply to all treaties, including treaties concluded prior to the release of the revised Guidelines.

6 December 2011 TEI-CRA Liason Meeting Roundtable Q. 11, 2011-04273091C6

As many treaties have limitation periods for making assessments, CRA considers it inadvisable to delay making a Part XII tax assessment arising from a transfer pricing adjustment (e.g.. a secondary adjustment arising under s. 214(3)(a)) until the transfer pricing issue has been resolved. However, a:

Part XIII collection policy has been adopted and applied by CRA in recognition of the OECD guidelines on Transfer Prcing by allowing MNE's to post acceptable security in lieu of the 100% payments required by the Income Tax Act.

6 December 2011 TEI-CRA Liason Meeting Roundtable Q. 6, 2011-0427261C6

As part of a discussion of the advance pricing agreement program, CRA stated:

We have determined that business restructuring cases are not suitable for an APA as they do not cover recurring and unchanging transactions where the underlying assumptions that form the basis of an APA transfer pricing methodology do not change over the duration of both the immediate pre-APA period and the APA period itself.

6 December 2011 TEI-CRA Liason Meeting Roundtable Q. 10, 2011-0427291C6

As part of a response to a query that noted that CRA auditors often raise potential transfer pricing adjustments simply because it is easy to do so and proposed that CRA develop a coordinated approach to transfer pricing audits with the IRS, CRA stated:

The fact that a multinational enterprise (MNE) has documented its analysis of arm's length prices and has not attempted to reduce its overall tax liability is not proper assurance that all facts and circumstances have been considered and that income has been adequately allocated between jurisdictions.

6 December 2011 TEI-CRA Liason Meeting Roundtable Q. 12, 2011-0427311C6

After noting that (in comparison to the 1995 version) the 2010 version of the OECD Transfer Pricing Guidelines did not so much de-emphasize the hierarchy of transfer pricing methods (e.g., the comparable uncontrolled price method when available being preferable to the resale price method) as focusing on the degree of comparability under each mehod and the reliability of the available data, and that the 2010 Guidelines "are more direct about the need to use data segmentation rather than company-wide data for testing net profit from a controlled transaction," CRA stated that it "endorses the application of the arm's length principle and the 2010 version of the TPG for the administration of the Income Tax Act in transfer pricing matters."

TPM-06 "Bundled Transactions" 16 May 16 2005

Even though there is no explicit reference to a bundled transaction or a requirement to separately price property or services in the Act (other than section 68, which provides for the specific allocation of consideration between the disposition of property and the provision of services), bundling can result in a transfer pricing adjustment if the terms and conditions of the bundled transaction fail to meet the arm's length standard. An example would be the provision of installation services in combination with the sale of tangible property. If the taxpayer's transfer price amounted to what would have been paid for the tangible property alone, an adjustment would be appropriate to include the arm's length price of the installation services.

CRA then refers to Information Circular IC87-2R, International Transfer Pricing, stating that "in particular, paragraphs 36 to 42 are relevant to bundling and unbundling."

1999 TEI Roundtable Q. , 1999-0010070

Where a Canadian parent corporation and its U.S. subsidiary participate in a shared credit facility and each guarantees the loan made to the other, the Canadian parent will be deemed to receive a fair market value guarantee fee.

Articles

Derek G. Alty, Brian M. Studniberg, "The Corporate Capital Structure: Thin Capitalization and the ‘Recharacterization' Rules in Paragraphs 247(2)(b) and (d)", Canadian Tax Journal, (2014) 62:4, 1159-1202.

Dropping of explicit "recharacterization" reference and addition of non-tax purpose test to revised s. 247(2) (p. 1168)

In response to criticism from commentators of the September 1997 draft, the final version of the legislation prepared by the Department of Finance eliminated the right to "recharacterize" (but retained the right to "adjust... the quantum or nature" of intercompany payments, which might be recharacterization by another name, and explains why the rule is conventionally referred to as the recharacterization rule). The final version also included the stipulations that the transaction would not have been entered into by persons dealing at arm's length and the transaction "can reasonably be considered not to have been entered into primarily for bona fide purpose other than to obtain a tax benefit."

Per OECD, Art. 9 permits recharacterizing debt where it is equity in economic substance (pp. 11176-7)

[T]he [Canada Revenue Agency] information circular [87-2R] notes that "Section 247 is intended to reflect the arm's length principle expressed in the OECD Guidelines." It also states the following:…

As a general rule, specific provisions of the Act—relating to loans and other indebtedness to or from non-residents, which are contained in sections 17 and 80.4, subsections 15(2) and 18(4)—would be applied before considering the more general provisions of section 247. These specific provisions deal with situations in which a Canadian corporate taxpayer:…

is thinly capitalized

As noted in the CRA's information circular, the Canadian recharacterization provisions are intended to encompass the concept of recharacterization set out by the OECD in the 1995 transfer-pricing guidelines. The relevant portions of the guidelines (taken from the 2010 version) read as follows:…

[I]n other than exceptional cases, the tax administration should not disregard the actual transactions or substitute other transactions for them….

However, there are two particular circumstances in which it may, exceptionally, be both appropriate and legitimate for a tax administration to consider disregarding the structure adopted by a taxpayer in entering into a controlled transaction. The first circumstance arises where the economic substance of a transaction differs from its form….An example of this circumstance would be an investment in an associated enterprise in the form of interest-bearing debt when, at arm's length, having regard to the economic circumstance of the borrowing company, the investment would not be expected to be structured in this way….

The second circumstance arises where, while the form and substance of the transaction are the same, the arrangements made in relation to the transaction, viewed in their totality, differ from those which would have been adopted by independent enterprises behaving in a commercially rational manner and the actual structure practically impedes the tax administration from determining an appropriate transfer price. An example of this circumstance would be a sale under a long-term contract, for a lump sum payment, of unlimited entitlement to the intellectual property rights arising as a. result of future research for the term of the contract…

A non-resident parent's decision to (re)capitalize a Cdn. Sub lacks the attributes of an arm's length transaction, so that this unexceptional transaction should be addressed solely by the thin cap rule (p. 1192)

[R]egardless of the initial capital structure choices, it could be argued that it is always possible to recapitalize the Canadian subsidiary to the maximum extent permitted under subsection 18(4). A parent company's decision to capitalize a subsidiary corporation is not something that could (ever) be undertaken by arm's-length parties; this explains why the Act provides for annual testing of the deductibility of the subsidiary's interest under subsection 18(4) in accordance with the then-prevailing policy of the Department of Finance regarding the permitted debt-to-equity ratio.

Because the Canadian thin capitalization rules use an arbitrary ratio, there will necessarily be some winners and some losers on the basis of industry norms (leaving aside a treaty-based argument when a Canadian borrower is underleveraged by industry standards but otherwise restricted by the thin capitalization rules). We believe that there is a strong argument to be made when the Canadian borrower is overleveraged by industry standards (and there is no issue with the character of the equity), but is compliant with the thin capitalization rules, there is little scope for paragraph 247(2)(b) or (d) to adjust the nature of the interest payment on the intercompany debt. If this were not the case, the application of paragraph 247(2)(b) or (d) would have the effect of indirectly modifying the statutory ratio.

Would the arm's length version of a (recharacterized) transaction change post-implementation (p. 1201)?

[T]he CRA would not be concerned with an increase in the Canadian subsidiary's equity on account of greater retained earnings (regardless of their cause, whether better-than-expected market performance or improved operating conditions). It is therefore difficult to see why declines in the equity value on account of the inverse of these types of factors should matter (as long as they do not represent returns of capital to a non-resident shareholder).

In discussing advance pricing arrangements at paragraph 4.125 of the 2010 transfer-pricing guidelines, the OECD states that it would not be reasonable to assert that an arm's-length short-term borrowing rate for a certain company's intragroup debt would remain at the same rate during the entire term of an advance pricing arrangement. Similarly, regardless of the rationale for a particular capital structure when implemented, if the arm's-length version of the structure would have changed over time, the OECD's view can arguably be extended to require a dynamic approach to recharacterization.

Ilana Ludwin, "Application of the Transactional Profit Split Method in Canada", Tax Management International Journal, 2015, p. 98.

Release of OECD Discussion Draft of TPSM (p. 98)

The Organisation for Economic Co-operation and Development (OECD) recently released its draft public discussion paper on the application of the Transactional Profit Split Method (TPSM) to global value chains… .

[T]he TPSM is intended to divide the profits between the parties on the basis of how much value each party contributed to the transaction, which is presumed to reflect an arm's-length division.

Code s. 482 accommodation of transfer pricing at entity level (p. 100)

Unlike the Canadian transfer pricing provision, the American provision only requires the taxing authority to conclude that an allocation of amounts is necessary to prevent evasion or to clearly reflect the parties' income or profit. No specific terms or conditions relating to individual transactions need be identified; the situation can be assessed on an aggregate entity profit level.

OECD Model, Art. 9 accommodation of considering overall commercial relations (p.101)

As with the American provision, Article 9 does not require consideration of particular transactions but rather the overall commercial or financial relations between two enterprises. The requirement under the Canadian provision that specific terms and conditions in relation to individual transactions be identified and adjusted present a potential barrier to using the TPSM in the Canadian context.…

Incompatibility of ss. 247(2)(a) and (c) with TPSM (p. 101)

[I]n the complex transactions for which the TPSM is particularly suited, it will not always be possible to use the TPSM to reverse-engineer specific prices, terms, and conditions for each transaction and participant in the manner required by paragraphs 247(2)(a) and (c)….

Although the TPSM is theoretically applicable to individual transactions, in practice it is often sought to be applied to assess profits and contributions at an aggregate transaction or even enterprise level due to the lack of granularity in the available financial data. In such cases, it will often be unsuitable for use as a primary method in the Canadian context as it will fail to comply with the requirements of paragraphs 247(2)(a) and (c) to provide transactions or series-of-transactions level data….

Mark D. Brender, Marc Richardson Arnould, Patrick Marley, "Cross-Border Cash-Pooling Arrangements Involving Canadian Subsidiaries: A Technical Minefield", Tax Management International Journal, 2014, p. 345.

Cash pooling description (p.345)

[W]e will examine a typical cash-pooling arrangement involving a Canadian subsidiary of a multinational group. Under such an arrangement, each member of the pool, including the Canadian subsidiary ("Canco"), transfers funds to, and/or receives funds from, a group member that is designated as the pool head, in this case a foreign subsidiary ("Forco") of the foreign parent corporation, resulting in intragroup payables and receivables between the pool members, including Canco and the pool head.

Primacy of specific provisions per IC 87-2R (p. 346)

[T]he transfer pricing provisions of the Act should not generally apply if the more specific provisions of the Act apply….

The CRA has interpreted that statement as meaning that the more specific provisions should be applied first before considering the application of §247. [fn 6: …2003-0033891E5] This statement is not to be taken to mean that there is an automatic exemption from the transfer pricing rules because of the mere existence of a specific provision that targets certain intra-group financing arrangements in a cross-border context; rather, the more specific provisions should be applied first and, if they do not apply, the application of the transfer pricing rules should be considered. For example, the CRA was of the view that §247(2) could apply to an outbound loan to which §17(1) did not apply by virtue of the fact that the indebtedness was not outstanding for more than one year.

J. Harold McClure, "Evaluating Whether a Distribution Affiliate Pays Arm's-Length Prices for Mining Products", Journal of International Taxation, July 2014, p. 33.

Development of Berry ratio (p. 37)

E.I. DuPont de Nemours & Co., 608 F.2d 445 (Ct. CL, 1979), was an influential transfer pricing case. As an expert witness for the U.S. government, Dr. Charles Berry said that the gross margin of a distributor under arm's length prices depends on its value-added expenses as a percentage of sales. The taxpayer argued that its Swiss distribution affiliate deserved a 25% gross margin; simply because most publicly traded distributors in their sector had gross margins near 25%. While these publicly traded distributors tended to have extensive functions with operating expense-to-sales ratios near 20%, the Swiss distribution affiliate performed limited functions, with operating expenses being only 8% of sales. Dr. Berry said that since the ratio of gross profits to operating expenses for the publicly traded distributors was around the gross margin for the Swiss affiliate should be 1.25 times 8% or 10%.

Application of Berry ratio to related distributor with lower operating costs (p. 38)

Clark Chandler and Irving Plotkin discussed the use of the Berry ratio: [fn 14: "Economic issues in Intercompany Transfer Pricing" BNA Transfer Pricing Rep't. October 20, 1993]

One problem often encountered in using gross margin data obtained from independent distributors to determine transfer prices in related-party transactions is that independent distributors may incur operating costs that are significantly higher or lower than those of the related party. Such differences in operating costs may occur because of differences in the range; of functions performed, the intensity with which they are performed, efficiency considerations (e.g., economies of scale) Or access to unique intangibles...[T]he Berry Ratio approach assumes that distributors' capital requirements vary in direct proportion to their operating expenses. While Dr. Berry makes this assumption due to the difficulty often encountered in measuring economic assets, the Berry Ratio approach is appropriate only if there is specific reason to believe that operating expenses and capital requirements are closely related. In many cases, they are not.

Off-take agreements to transfer risk to distributor (p.41)

[O]ff-take agreements are sometimes entered into to guarantee the owner of natural resources that his future revenues will provide a reasonable return on investment. The buying entity in off-take agreements agrees to pay a certain future price to the producing entity for its production. These agreements are normally negotiated prior to the construction of a facility, such as a mine, to secure a market for the future output of the facility.

The discussion above treated the producer as the entrepreneur entitled to the economic rents from the ownership of natural resources. Thus, the analysis of transfer pricing methodology treated the distributor as the tested party. In an off-take agreement, the distributor becomes the entrepreneur. Since the distributor takes the downside risk that spot prices will be below the agreed on future price, it also should receive the upside potential. Off-take agreements can, therefore, be seen as reversing which entity should be the tested party.

Examples of off-take agreemnts (pp. 41-2)

A recent example…is the arrangement between Glencore and Orbitae Aluinae Inc. …The agreement says that Glencore will purchase all of smelter-grade alumina from Orbite's proposed polan in Quebec for the first ten years of production. Glencore also recently entered into an off-take agreement with Sirius Petroleum… .Off-take agreements are widely used in the mining and oil sectors. … In other situations, they are between independent parties.

Cameco lititgation (p. 42)

Cameco Corp v. The Queen

is a transfer pricing dispute between a Canadian-based producer of uranium and the: Canadian Revenue Agency for 2003-2012 and could involve C$1.6 billion in taxes. [fn 21: Can. Tax Ct, No. 2009-2430(IT)G. See Menyasz, "Canada Tax Court Orders More Disclosure in Cameco Corp.'s Transfer Pricing Dispute," BNA Int'l Tax Monitor, February 26. 2014.] A Swiss affiliate, Cameco Europe Ltd., purchased uranium from the Canadian producer at $10 per pound under a 1999 intercompany agreement in which .this price was fixed for a 17-year period. During the commodity boom, the market price of uranium rose dramatically, peaking at $140 a pound before reverting to approximately $40 a pound.

Veritas Investment Research discussed this transfer pricing issue and its tax implications in an April 2, 2013, report. The report said that Cameco's long-term contract with its Swiss marketing affiliate exposed the Swiss affiliate to the downside risk when uranium prices were low as well as the upside potential if uranium prices rose. This point is consistent with the argument herein that off-take arrangements may shift such risk to the marketing entity and away from the producer….

Jules Lewy, Joel A. Nitikman, "Important Developments in Canadian Transfer Pricing", CCH Tax Topics, Number 2185, January 23, 2014, p. 1

Commissions charged by Elk to Japanese affiliate for securing logs (p.4)

Elk Trading [fn 5: Joel A. Nitikman was counsel for Elk.]

This appeal was filed in 2012 [fn 6: TCC Appeal No. 2012-3423(IT)G.]...[fn 7: ...In addition, the Minister assessed Elk...for a failure to withhold 5% of the dividends deemed to have been paid to Emachu... .]... Elk was a Canadian company. It was related to and, hence, not dealing at arm's length with a Japanese company, Emachu. Emachu purchased logs and lumber from around the world and resold it in Japan. In 1973, Emachu had established Elk in Canada to assist in finding Canadian logs and lumber.

…For each business segment, Emachu would specify the exact logs or lumber required and the price. Elk would find that material at that price, purchase it in Canada, and then resell it to Emachu. For these services, Elk charged a commission equal to a percentage of all costs incurred in reselling the logs and lumber, including the original purchase price, insurance, freight, etc….

CRA reassessed Elk by applying transactional net margin method (p.4)

The Minister reassessed Elk. However, rather than specify what the arm's length commission should have been, the Minister applied the TNMM. As a first step, the Minister did a database search…This resulted in exactly one comparable company, a US, publicly listed company that arranged for the delivery of automobiles ("USco"). The Minister then calculated USco's Return on Total Costs ("ROTC", being the profit USco earned as a percentage of its total costs. The Minister then increased Elk's gross revenue in each taxation year until its ROTC equaled USco's ROTC.

The case law in Canada is clear that because paragraphs 247(2)(a) and (c) refer to the "terms and conditions" of a transaction, the Crown is not permitted simply to plead that the taxpayer's prices are not arm's length prices. The Crown must go further and specify exactly what the arm's length prices should have been in the taxpayer's situation. [fn 8: See ... General Electric ... .]

Implicit CRA acceptance of commission approach (p. 4)

...Elk filed a Notice of Motion...on the basis that the Crown's Reply had no reasonable prospect of success.

The Crown has now filed a Consent to judgment allowing the appeal in full, with costs. This is, essentially, an admission that the TNMM, at least in the manner in which it is used in this case, cannot apply under the "terms and conditions" rule in paragraphs 247(2)(a) and (c)….

Brian Bloom, François Vincent, "Canada's (Two) Transfer-Pricing Rules: A Tax Policy and Legal Analysis", 2011 CTF Conference Report, 20:1-40.

Objective of s. 247

20:3 The main objective in introducing new part XVI.1 [of the Act] was to enshrine the ALP [arm's length principle] in the Act's TPRs [transfer-pricing rules], thereby leaving no doubt about the standard by which the Act prices, and thus measures a taxpayer's income from, controlled transactions.

20:4 Taken literally, the ALP establishes an unattainable goal: in the absence of a Star-Trek-like holographic simulator or a quantum leap in game theory computer modelling, it is not possible to determine how the parties to the transaction would have priced the transaction had they been dealing with each other at arm's length.

Absence of "in the circumstances"

20:5 In this regard, one rather notable omission that distinguishes subsection 247(2) from its predecessors is the lack of any explicit reference to the price that would have been used "in the circumstances" had the parties to the controlled transaction been dealing with each other at arm's length. The reason for this omission, we submit, is that the quoted words are implicit in the comparative exercise mandated by the explicit adoption of the ALP in subsection 247(2).

Exclusion of non-commercial transactions

20:8 Article 9 of the OECD model convention is concerned with the pricing of "commercial" and "financial" transactions, and the guidance provided by the OECD with respect to article 9 and the ALP is aimed at those kinds of transactions. Accordingly, part XVI.1 of the Act, in our view, is not intended to apply to transactions that take place outside of a commercial context (such as cross-border gifts between siblings), despite the fact that, on its face, subsection 247(2) makes no distinction between commercial and personal transactions. Finance had contemplated expressly limiting subsection 247(2) to "commercial" transactions but feared that any such limitation could be exploited by taxpayers and, in any case, had been assured by the CRA that the TPRs would be applied only in a commercial setting.

Scope of recharacterization provision

20:17-18 The OECD guidelines state that there are two circumstances in which it may, exceptionally, be appropriate for tax administrators to recharacterize controlled transactions: ...

The first such circumstance arises where the economic substance of a transaction differs from its legal form. ... We understand that the incorporation of such a test into the TPRs was considered by Finance and rejected for a number of reasons.

The main reason for eschewing an economic substance test in the transfer-pricing context was that it conflicted with the way Canada generally taxed under the Act.

20:19 The second circumstance identified by the OECD guidelines occurs where "the arrangements made in relation to the transaction, viewed in their totality, differ from those which would have been adopted by independent enterprises behaving in a commercially rational madder and the actual structure practically impedes the tax administration from determining an appropriate transfer price.

The second circumstance thus has two components. First, the transaction must be one that, when viewed as a whole, would not have been entered into by independent enterprises behaving in a commercially rational manner. In other words, the transaction must be one that is manifestly contrary to the commercial interests of the relevant party. Second, the transaction must have been structured in this commercially irrational manner in order to impede the tax authorities' ability to determine an arm's-length price under normal TPRs or to achieve some other tax benefit for the party. The application of normal TPRs is impeded because there are no arm's length comparables upon which to base a transfer-pricing assessment.

20:24-25 [T]he recharacterization rule in paragraph's 247(2)(b) and (d) is an exceptional or abnormal one. To employ the normal TPR in paragraphs 247(2)(a) and (c) to effectively recharacterize transactions would turn the integrated scheme of the TPRs, the Act, and the MAP provisions of Canada's tax treaties on its head. Unfortunately–despite the negative ramifications of using paragraphs 247(2)(a) and (c) to recharacterize transactions, despite the fact that TPRs are basically intended to price (actual) controlled transactions, despite the clear statement in the OECD guidelines that recharacterization is an exceptional remedy, despite the apparent symmetry between the OECD guidelines' second circumstance and the conditions of paragraph 247(2)(b), and despite the juxtaposition of paragraphs 247(2)(a) and (c) with an overt recharacterization rule in paragraphs 247(2)(b) and (c)– that appears to be precisely what the CRA is doing... .

20:32-33 Indeed, if the CRA can recharacterize a transaction simply by adjusting the "nature" of amounts pursuant to paragraphs 247(2)(a) and (c), then recourse to the specific recharacterization provisions of section 247 and compliance with the conditions of paragraph 247(2)(b) become unnecessary. Clearly, this approach would constitute an unauthorized and unprincipled unification of Canada's dualistic transfer-pricing regime.

Robert Couzin, "Policy Forum: The End of Transfer Pricing?", Canadian Tax Journal, (2013) 61:1, 159-78, at 172: He compares the approach to recharacterization in s. 247 of the Act and by the OECD:

[There is] the occasional need to "recharacterize" a transaction, as is permitted under the OECD guidelines where the transaction differs from what independent enterprises would do and it cannot be priced according to the arm's-length principle. [fn 36: OECD Transfer Pricing Guidelines, see for example, Organisation for Economic Co-operation and Development, OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (Paris: OECD, July 2010), at paragraph 4.8, and Canada Revenue Agency, Transfer Pricing Memorandum TPM-09, "Reasonable Efforts Under Section 247 of the Income Tax Act," September 18, 206, at paragraph 1:65] In such a case, the tax administration may disregard the actual transaction and recast it as the one that arm's-length parties would reasonably be expected to have done. [fn 37: Paragraph 247(2)(b) of the Canadian Income Tax Act, RSC 1985, c. 1 (5th Supp.), as amended, enacts a slightly different rule, substituting a "dominant tax benefit" test for the OECD's "unpriceability," although whether these are really different is a good question. The OECD guidelines do not refer to tax avoidance in this context, but the text seems to suggest it. What about bona fide commercial transactions that have no equivalent outside the MNE? If tax authorities can neither recharacterize transactions nor apply the arm's-length principle, what are they called upon to do?] In a simple comparison case (sale or lease, for example), this sounds almost plausible, but in most cases it is sophistry.

Robert Feinschreiber, Margaret Kent, "OECD Transfer Pricing Guidelines and the 'Highly Uncertain' Valuation of Intangibles", Journal of International Taxation, February 2012, p. 47

Includes in Exhibit 2 a list of transfer pricing issues for the pharmaceutical industry which the OECD should address.

Richard G. Tremblay, "Canadian Transfer Pricing - The Arm's-Length Principle - Filling in the Blanks - Does an Arm's Length Price Ever Differ From Fair Market Value?", Tax Management International Journal, 2011, p. 599

The answer is "yes."

Johan Mayles, "CRA to Adopt OECD's Revised Transfer Pricing Guidelines", CCH Tax Topics, No. 2036, 17 March 2011, p.1

Review of comments of Jennifer Ryan, Director of International Tax division of the CRA at 24 February 2011 OBA section meeting - "CRA adheres to the guidelines of the OECD and therefore it will be updating its current position in respect of the hierarchy of methodologies."

Danny Oosterhoff, Bo Wingerter, "The New OECD Guidelines: The Good, the Bad and the Ugly", International Transfer Pricing Journal, Vol. 18, No. 2, March/April 2011, p. 103.

Janice McCart, "Repatriation in Lieu of Secondary Adjustments", International Transfer Pricing Journal, Vol. 17, No. 1, January/February 2010, p. 65

Giammarco, Cottani, "OAC Discussion Draft on Transfer Pricing Aspects of Business Restructurings", Summary of Business Comments and Issues for Discussion", International Transfer Pricing Journal, Vol. 16, No. 4, 2009, p. 231.

Jennifer Rhee, "Unmasking 'Management Fees' - What's in a Name?", CCH Tax Topics, No. 1897, July 17, 2008, p. 1.

Brian Bloom, "Paragraph 247(2)(b) Demystified", CCH Tax Topics, 11 May 2006, No. 1783, p. 1.

Muris Dujsic, Matthew Billings, "Establishing Interest Rates in Intercompany Contacts", International Transfer Pricing Journal, Vol. 11, No. 6, November/December 2004, p. 247.

Todd Miller, Ryan Morris, "Canadian Subsidiary Guarantees for Foreign Parent Borrowings", Tax Notes International Vol. 34, No. 1, 5 April 2004, p. 63.

Bruce Sinclair, Robert Kopstein, "Guaranteed to Enlighten: The Impact of Guarantees on Financing Arrangements", 2000 Conference Report, c. 22.

Richard G. Tremblay, James Fuller, "Tax Consequences of Cross-Border Guarantee Fees", International Tax Planning, Vol. X, No. 3, 2001, p. 716.

Ivan Williams, "Contract Manufacturing Strategies: Tax-Saving Options for Intercompany Profit Allocation", Tax Topics, 21 March 2002, No. 1567, p. 1.

Robert Turner, "Cost Contribution Agreements", International Transfer Pricing Journal, 2001 Vol. 8, No. 3, p. 89.

Robert Turr, "Practical Application of Transactional Profit Methods", International Transfer Pricing Journal, Vol. 7, No. 5, September/October 2000, p. 184.

Jack Bernstein, "Transfer Pricing in Canada", Bulletin for International Fiscal Documentation, Vol. 53, No. 12, 1999, p. 570.

Janice McCart, Emma Purday, "What's The Deal? - Canada's New Rules on Arm's Length Pricing and Bundled Transactions", Tax Management International Journal, Vol. 28, No. 10, 8 October 1999, p. 633.

F. Vincent, I.M. Freedman, "Transfer Pricing in Canada: The Arm's Length Principle and the New Rules", 1997 Canadian Tax Journal, Vol. 45, No. 6, p. 1213.

Tipping, "British Bankers Comment on OECD's Draft on Global Trading of Financial Instruments", Tax Notes International, Vol. 15, No. 14, 6 October 1997, p. 1119.

Subsection 247(4)

Administrative Policy

TPM-05R – Requests for Contemporaneous Documentation 28 March 2014

9. [issuance of requests] Requests for contemporaneous documentation must be issued at the stage of initial contact with the taxpayer in all audits where there are transactions (as defined in subsection 247(1) of the Income Tax Act) between a taxpayer and a non-resident person with whom the taxpayer does not deal at arm's length….

11. [by letter] Contemporaneous documentation requests must be issued by letter….

13. [APA coordination] [I]n all situations where the taxpayer already has an APA, which may or may not include a rollback period, or has made claims to request one, auditors must contact the Competent Authority Services Division before issuing the request for contemporaneous documentation to evaluate whether the request should be issued….

17. [s. 247(4)(c): "within 3 months"] Under paragraph 28(c) of the Interpretation Act, the day on which the three-month period expires will bear the same calendar day number as the specified day….

18. [ "within 3 months" examples] [W]hen a request is served on April 30, the taxpayer has until July 30 to provide the documentation, not July 31. However, if a request is served on January 31, the taxpayer has until April 30 to provide the documentation… If the request is served on November 30, the taxpayer has to provide the documentation by February 28 of the following calendar year (or February 29 in the case of a leap year).

19. [extension if holiday] When the last day to comply falls on a holiday, the taxpayer has until the next day that is not a holiday to comply, according to section 26 of the Interpretation Act. A holiday includes statutory and provincial holidays, Saturdays, and Sundays….

26. [updating responsibility] In accordance with paragraph 247(4)(b), taxpayers still have the responsibility to provide updates to contemporaneous documentation they submitted previously concerning prior audit years. If there have been no material changes, taxpayers must still respond within the three-month period stating that there have been no material changes and give the reasons that support this position.

29. [PATA] Taxpayers may choose to use the Pacific Association of Tax Administrators (PATA) Transfer Pricing Documentation Package in order to avoid the imposition of PATA member transfer pricing penalties with respect to a transaction. The documentation package provides an exhaustive list of documents that the PATA tax administrators view as necessary to provide transfer pricing penalty relief.

Articles

Martin Przysuski, Srini Lalapet, "Appropriate Canadian Transfer Pricing Documentation", Tax Notes International, 3 October 2005, p. 55.

Subsection 247(7)

Articles

Brian Bloom, "A Policy of Disengagement: How Subsection 247(2) Relates to the Act's Income- Modifying Rules", CCH Tax Topics, No. 1957, 10 September 2009, p. 1.

Subsection 247(7.1)

Administrative Policy

31 March 2014 T.I. 2013-0515661E5 - Subsection 247(7.1) coming into-force rule

"that day" in transitional election refers to Royal assent

The election [in the coming-into-force provision] is intended to provide a taxpayer the benefit of an exception to the transfer price adjustment required by subsection 247(2) of the Act to a statute-barred year that it would have been entitled to had the legislation been enacted as of its effective date. As such, the phrase "that day" in paragraph 88(2)(a) of the coming into-force rules must be in reference to the date the legislation was enacted.

Articles

Geoffrey S. Turner, "Downstream Loan Guarantees and Subsection 247(7.1) Transfer Pricing Relief", CCH Tax Topics, No. 2166, September 12, 2013, p.1:

Narrowness of (active business) requirement of s. 247(5.1) (p. 2)

The proposed subsection 247(7.1) relief from transfer pricing requirements will, of course, be very helpful in many foreign affiliate financings guaranteed by the Canadian parent company. However, the "active business" conditions of subsection 17(8) are strict and not always possible to satisfy. For instance, a foreign affiliate borrowing used to pay a dividend would not qualify for the relief nor would a loan used to refinance a prior borrowing not directly traceable to a qualifying purpose (e.g., a prior borrowing incurred by the foreign affiliate before it was acquired by the Canadian parent, when the Canadian rules were not relevant to it).

Lack of neutrality compared to on-loan structure (pp. 2-3)

If the Canadian transfer pricing rules insist on payment of a guarantee fee where the borrowing is made directly by the foreign affiliate with credit support from the parent, the Canadian parent would suffer an additional income inclusion that would not be incurred if the borrowing were made in Canada and advanced to the foreign affiliate. In many cases, the guarantee fee requirement would lead the Canadian parent to prefer a borrowing in Canada followed by an advance to the foreign affiliate. In this way, the constrained scope of the exemption in subsection 247(7.1) leads to a distortion, or non-neutrality, in the financing decision and may discourage borrowings in the foreign country in favour of borrowings in Canada.

Protection of Canadian tax base even where no-fee guarantee for debt of CFA earning FAP (p.3)

After providing an example to illustrate this point, Geoff stated:

In other words, with the Canadian parent guarantee of a controlled foreign affiliate borrowing to earn FAPI, the corporate group as a whole is economically better off by virtue of the interest rate savings, and these savings are captured in the Canadian tax base with or without payment of a guarantee fee to the Canadian parent. Accordingly, it is not clear why the relief in subsection 247(7.1) should be constrained so as to effectively force the payment of a guarantee fee when the borrowed funds are not deployed in an active business.

CRA's position in GE cases is favourable where the parent is Canadian rather that U.S. (p.4)

The significance of these General Electric cases is that throughout this period, and despite losses at the Tax Court of Canada and the Federal Court of Appeal, the CRA has continued to aggressively assert its position that the US parent guarantee of the debt of the Canadian subsidiaries had at most nominal value, because the Canadian subsidiaries already benefited in any event from the implicit guarantees of the US parent.

In light of the CRA's consistently advanced position with respect to the negligible or nil value of parent guarantees, it would be inconsistent for the CRA to assert transfer pricing adjustments or penalties where there is no contemporaneous documentation, against any Canadian parent corporation that has guaranteed the debt of its foreign affiliate, even if the guarantee is outside the scope of the exemption in proposed subsection 247(7.1).

Subsection 247(8)

Administrative Policy

19 December 2013 Memorandum 2013-0490751I7 - Adjustment to a taxpayer`s CDA

s. 247(2) trumps s. 69(1)

The taxpayer, which was a private corporation, disposed of eligible capital property to a non-arm's-length non-resident sister company ("SisterCo") within the same multinational group in consideration for a promissory note. Audit proposed to apply s. 69(1) or s. 247(2) to increase the proceeds from the disposition. In suggesting s. 247(2), the Directorate stated:

[S]ubsection 247(8) specifically provides that subsection 69(1) shall not apply where subsection 247(2) is applied to adjust the terms and conditions of the transaction under review.

Subsection 247(10)

Administrative Policy

Update - Competent Authority Services Division, 20 December 2013

using MAP

Where a Canadian entity requests a reduction of its Canadian taxable income (downward transfer pricing adjustment) where the request relates to a self-initiated (that is, not initiated by a tax authority) adjustment to increase the income of a related entity in another country (upward adjustment), the Canadian competent authority will accept the case under the Mutual Agreement Procedure in these circumstances:

The upward adjustment has been accepted for consideration by the foreign tax authority;
The foreign competent authority tries to resolve the case under the MAP. That is, the foreign country reviews the case, provides the Canadian competent authority with a detailed analysis as to why the foreign authority agrees with the adjustment and agrees to negotiate the case.
The request for competent authority assistance is made within the time limits of the applicable treaty; and
The issue is not one that the Canadian competent authority has decided, as a matter of policy, not to consider.

If one of these requirements is not met:

The Canadian competent authority will close its MAP case. The taxpayer will then have the option to apply to the Audit Division of the local tax services office to ask for a downward adjustment, in accordance with...TPM-03... .

Memorandum TPM-03 "Downward Transfer Pricing Adjustments Under Subsection 247(2)," 20 October 2003

The Minister may decide not to exercise his discretion under s. 247(10) where a Canadian company requests a decrease in the transfer price of sales to a non-arm's length non-resident without repatriation, and s. 15(1) does not apply to the amount. ("This situation may be considered abusive because the Canadian taxpayer has turned an otherwise taxable receipt of monies into a non-taxable amount.") Conversely, when a Canadian parent company requests and receive a decrease in the transfer price of sales to a non-resident subsidiary without repatriation, this is not considered abusive, because s. 15(1) would apply and offset the downward adjustment.

Articles

Nathan Boidman, "Canadian Approach to Downward Pricing Adjustments: CCRA's 18 March 2003 Communiqué", International Transfer Pricing Journal, Vol. 10, No. 5 2003, p. 181.

Subsection 247(12)

Administrative Policy

19 November 2014 Memorandum 2014-0530911I7 F - Transfer pricing secondary adjustments

no secondary adjustment where downward s. 247(2) adjustment to Canadian branch expense

An expense is incurred by a non-resident corporation, which carries on business in Canada through a permanent establishment, and paid to a non-resident with which it does not deal at arm's length, will be adjusted downwards under s. 247(2) as being in excess of an amount that would have been agreed by arm's length persons. Does s. 247(12) apply? The Directorate stated (TaxInterpretations translation):

[T]he requirement that the corporation in question reside in Canada for Part XIII to apply is not satisfied when subsection 212(13.2) is involved because this subsection deems residence in Canada only for purposes of an amount which is deductible in computing taxable income earned in Canada.

However, since Part XIV tax is payable in respect of taxable income earned in Canada, an adjustment to such income can increase the tax payable under such Part. This fact reinforces our conclusion that subsection 247(12) cannot apply to payments referred to in subsection 212(13.2) made by persons who are not resident in Canada. Simultaneous levies of tax under Parts XIII and XIV respecting the same sum would result in double taxation which, in our view, would not accord with the legislative intention… . In the event the taxpayer benefits…[from] subsection 219(2), the non-taxability of the sum reflects the legislative will… .

TPM-02 "Repatriation of funds by Non-residents – Part XIII assessments" 27 March 2003

Repatriation must be completed within 180 days from the time the repatriation agreement is signed.

Repatriation can be accomplished by:

Offsetting the Canadian company's inter-company accounts payable to the non-resident in the year of the transfer pricing adjustment. ...[I]nterest charges may have to be amended based on the revised inter-company balances.

Creating or adjusting a shareholder loan account. This may result in a Part XIII assessment because of thesubsection 15(2) or subsection 15(9) implications. Repaying the shareholder loan may result in a refund undersubsection 227(6.1) of all or a portion of the tax previously assessed under Part XIII because of subsection 15(2).

Offsetting against a separate downward transfer pricing adjustment that relates to the same non-resident taxpayer. ...

Repatriation must be achieved in the tax year of the transfer pricing adjustment. ...

Where offsets are not available until tax years after that of the transfer pricing adjustment, the only option available to the taxpayer will be to create or adjust a shareholder loan account. Offsets may then be used as repayments of the shareholder loan.

...Transferring funds would be used in combination with creating or adjusting a shareholder loan account. The transfer of funds would then be a repayment against the shareholder loan account.

Articles

Joel A. Nitikman, "Section 247 – Secondary Adjustments, Deemed Dividends, Repatriation and Interest", International Tax Planning (Federated Press), Vol. XVIII, No.1, 2012, p. 1224, at p.1225

Where Canco pays an excessive amount to a Forper [namely, a particular non-resident person] that is a non-resident sister corporation in the same corporate group, subsection 247(12) makes it clear that the deemed dividend is paid to Forper, even if it is not a shareholder of Canco. This raises the problem that the deemed dividend may be subject to a full 25% withholding tax with no treaty reduction, because Forper may not reside in a treaty country even if its parent corporation does, or Forper may not be eligible for a reduction under its treaty as it may not be actually a shareholder of Canco or may not have a high enough percentage of shares to qualify for treaty benefits. Furthermore, it may be difficult to assert that any non-resident, even if it otherwise had sufficient shareholdings to qualify for treaty benefits, is the "beneficial owner" of a deemed dividend or meets and LOB clause in the treaty.

Subsection 247(13)

Articles

Joel A. Nitikman, "Section 247 – Secondary Adjustments, Deemed Dividends, Repatriation and Interest", International Tax Planning, Vol. XVIII, No.1, 2012, p. 1224, at p. 1226:

It is not clear why the reduction is only for the amount that the Minister considers appropriate....The Joint Committee recommended that the reduction be on a dollar-for-dollar basis with the repatriated amount. That recommendation was not accepted. Accordingly, one can expect to see applications for judicial review in the Federal Court if the Minister attempts to tax a dividend that is not reduced by the full amount repatriated.

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Table of Contents

Subsection 247(2)

Cases

GlaxoSmithKline Inc. v. The Queen, 2012 DTC 5147 [at 7338], 2012 SCC 52

The Queen v. General Electric Capital Canada Inc., 2011 DTC 5011 [at 5558], 2010 FCA 344

See Also

Re Nortel Networks Corp., 2014 ONSC 6973

AgraCity Ltd. v. The Queen, Docket: 2014-1537 (IT) G

McKesson Canada Corp. v. The Queen, 2014 DTC 1197 [at 3749], 2014 TCC 266

Marzen Artistic Aluminum v. The Queen, 2014 DTC 1145 [at 3433], 2014 TCC 194

McKesson Canada Corp. v. The Queen, 2014 DTC 1040 [at 2723], 2013 TCC 404

Burlington Resources Finance Company v. The Queen, 2013 DTC 1190, 2013 TCC 231

Alberta Printed Circuits Ltd. v. The Queen, 2011 DTC 1177 [at 967], 2011 TCC 232

Ford Motor Co. of Canada, Ltd. v. Ontario Municipal Employees Retirement Board, 2004 DTC 6224 (Ont. Sup. Ct. of J.)

Safety Boss Limited. v. The Queen, 2000 DTC 1767, Docket: 1999-1429-IT-G (TCC)

Administrative Policy

TPM-16 "Role of Multiple Year Data in Transfer Pricing Analyses" 29 January 29 2015

Selecting the most appropriate point in the range

Conclusion

TPM-15 "Intra-group services and section 247 of the Income Tax Act" 29 January 2015

Direct v. indirect charges

Shareholder costs

Allocation of corporate group costs

Duplicate costs

Looking through management fees to underlying non-deductible/withholdable items

Standby charges

Services fees mark-ups

Agency services

31 October 2012 TPM-14 "2010 Update of the OECD Transfer Pricing Guidelines"

TPM-06 "Bundled Transactions" 16 May 16 2005

Articles

Derek G. Alty, Brian M. Studniberg, "The Corporate Capital Structure: Thin Capitalization and the ‘Recharacterization' Rules in Paragraphs 247(2)(b) and (d)", Canadian Tax Journal, (2014) 62:4, 1159-1202.

Dropping of explicit "recharacterization" reference and addition of non-tax purpose test to revised s. 247(2) (p. 1168)

Per OECD, Art. 9 permits recharacterizing debt where it is equity in economic substance (pp. 11176-7)

A non-resident parent's decision to (re)capitalize a Cdn. Sub lacks the attributes of an arm's length transaction, so that this unexceptional transaction should be addressed solely by the thin cap rule (p. 1192)

Would the arm's length version of a (recharacterized) transaction change post-implementation (p. 1201)?

Ilana Ludwin, "Application of the Transactional Profit Split Method in Canada", Tax Management International Journal, 2015, p. 98.

Release of OECD Discussion Draft of TPSM (p. 98)

Code s. 482 accommodation of transfer pricing at entity level (p. 100)

OECD Model, Art. 9 accommodation of considering overall commercial relations (p.101)

Incompatibility of ss. 247(2)(a) and (c) with TPSM (p. 101)

Mark D. Brender, Marc Richardson Arnould, Patrick Marley, "Cross-Border Cash-Pooling Arrangements Involving Canadian Subsidiaries: A Technical Minefield", Tax Management International Journal, 2014, p. 345.

Cash pooling description (p.345)

Primacy of specific provisions per IC 87-2R (p. 346)

J. Harold McClure, "Evaluating Whether a Distribution Affiliate Pays Arm's-Length Prices for Mining Products", Journal of International Taxation, July 2014, p. 33.

Development of Berry ratio (p. 37)

Application of Berry ratio to related distributor with lower operating costs (p. 38)

Off-take agreements to transfer risk to distributor (p.41)

Examples of off-take agreemnts (pp. 41-2)

Cameco lititgation (p. 42)

Cameco Corp v. The Queen

Jules Lewy, Joel A. Nitikman, "Important Developments in Canadian Transfer Pricing", CCH Tax Topics, Number 2185, January 23, 2014, p. 1

Commissions charged by Elk to Japanese affiliate for securing logs (p.4)

CRA reassessed Elk by applying transactional net margin method (p.4)

Implicit CRA acceptance of commission approach (p. 4)

Brian Bloom, François Vincent, "Canada's (Two) Transfer-Pricing Rules: A Tax Policy and Legal Analysis", 2011 CTF Conference Report, 20:1-40.

Objective of s. 247

Absence of "in the circumstances"

Exclusion of non-commercial transactions

Scope of recharacterization provision

Robert Couzin, "Policy Forum: The End of Transfer Pricing?", Canadian Tax Journal, (2013) 61:1, 159-78, at 172: He compares the approach to recharacterization in s. 247 of the Act and by the OECD:

Robert Feinschreiber, Margaret Kent, "OECD Transfer Pricing Guidelines and the 'Highly Uncertain' Valuation of Intangibles", Journal of International Taxation, February 2012, p. 47

Richard G. Tremblay, "Canadian Transfer Pricing - The Arm's-Length Principle - Filling in the Blanks - Does an Arm's Length Price Ever Differ From Fair Market Value?", Tax Management International Journal, 2011, p. 599

Johan Mayles, "CRA to Adopt OECD's Revised Transfer Pricing Guidelines", CCH Tax Topics, No. 2036, 17 March 2011, p.1

Danny Oosterhoff, Bo Wingerter, "The New OECD Guidelines: The Good, the Bad and the Ugly", International Transfer Pricing Journal, Vol. 18, No. 2, March/April 2011, p. 103.

Janice McCart, "Repatriation in Lieu of Secondary Adjustments", International Transfer Pricing Journal, Vol. 17, No. 1, January/February 2010, p. 65

Giammarco, Cottani, "OAC Discussion Draft on Transfer Pricing Aspects of Business Restructurings", Summary of Business Comments and Issues for Discussion", International Transfer Pricing Journal, Vol. 16, No. 4, 2009, p. 231.

Jennifer Rhee, "Unmasking 'Management Fees' - What's in a Name?", CCH Tax Topics, No. 1897, July 17, 2008, p. 1.

Brian Bloom, "Paragraph 247(2)(b) Demystified", CCH Tax Topics, 11 May 2006, No. 1783, p. 1.

Muris Dujsic, Matthew Billings, "Establishing Interest Rates in Intercompany Contacts", International Transfer Pricing Journal, Vol. 11, No. 6, November/December 2004, p. 247.

Todd Miller, Ryan Morris, "Canadian Subsidiary Guarantees for Foreign Parent Borrowings", Tax Notes International Vol. 34, No. 1, 5 April 2004, p. 63.

Bruce Sinclair, Robert Kopstein, "Guaranteed to Enlighten: The Impact of Guarantees on Financing Arrangements", 2000 Conference Report, c. 22.

Richard G. Tremblay, James Fuller, "Tax Consequences of Cross-Border Guarantee Fees", International Tax Planning, Vol. X, No. 3, 2001, p. 716.

Ivan Williams, "Contract Manufacturing Strategies: Tax-Saving Options for Intercompany Profit Allocation", Tax Topics, 21 March 2002, No. 1567, p. 1.

Robert Turner, "Cost Contribution Agreements", International Transfer Pricing Journal, 2001 Vol. 8, No. 3, p. 89.

Robert Turr, "Practical Application of Transactional Profit Methods", International Transfer Pricing Journal, Vol. 7, No. 5, September/October 2000, p. 184.