Article 9


Re Nortel Networks Corp., 2014 ONSC 6973

provision, under multinational agreement for residual profit split method, for unilateral bearing of restructuring costs, represented appropriate ex ante risk allocation

In January 2009, Nortel Networks Corporation ("NNC"), which was the publicly-traded Canadian parent filed for protection under the CCAA, various U.S. subsidiaries filed for protection under chapter 11 of the U.S. Bankruptcy Code and its principal UK subsidiary ("NNUK") and most other European subsidiaries entered into administration under the U.K. insolvency laws. "R&D was the primary driver of Nortel's value and profit" (para. 8). Under Nortel's transfer pricing methodology, the entities performing R&D, including NNL and NNUK, were entitled to all residual profits after payment of returns to the Nortel subsidiaries that performed sales and distribution functions. In particular, under a Master Research and Development Agreement ("MRDA"), a residual profit split method was specified whereby each such performer of R&D was allocated a portion of a residual profit pool based on its percentage of yearly global R&D expenditures (para. 10). This methodology was supported by advance pricing agreements with the tax authorities in Canada, the U.S. and the U.K. (para. 132). The MRDA also specified that restructuring costs incurred by each R&D subsidiary were not to be shared (para. 137).

Newbould J. rejected the submission made by the administrators of the pension plan for NNUK made (at para. 130) "that the Nortel transfer pricing arrangements failed to compensate NNUK for the true contributions it was making to the Nortel Group …[and] in particular they … failed to properly compensate NNUK for its restructuring costs and its pension costs." He noted (at para. 134) that "the OECD Guidelines provide in section 1.64 and 1.65 that an examination of a controlled transaction should be based on the transaction actually undertaken by the associated enterprises as it has been structured by them except in two exceptional cases [respecting departures from economic substance or no commercial rationality]" and accepted (at para. 135) testimony of the monitor's expert that "neither of the exceptional cases…existed and thus in accordance with those guidelines the MRDA should stand and was dispositive of the issues." Conversely, the claimants' expert:

said that one starts with the economic substance and then looks to see if the legal form follows the economic substance. That is the opposite of what the OECD Guidelines call for (para. 139).


What he [the claimants' expert] has done is look at events after the time when the arrangements were made by the parties in the MRDA. As Dr. Reichert [for the monitor] explained, 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). (para. 142, see also para. 149)

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 247 - New - Subsection 247(2) provision, under multinational agreement for residual profit split method, for unilateral bearing of restructuring costs, represented appropriate ex ante risk allocation 188

Specialty Manufacturing Ltd. v. Canada, 99 DTC 5222 (FCA)

McDonald J.A. found that the capitalization of the taxpayer by non-resident related shareholders with close to 100% debt financing meant that the loans were those that no arm's-length lender would have made. Accordingly, it was not necessary to consider the taxpayer's argument that because the loans were those that arm's length persons would have made, Article 9 of the Canada-U.S. Convention effectively overrode the rule in s. 18(4) of the Act.

See Also

Chevron Australia Holdings Pty Ltd v Commissioner of Taxation, [2017] FCAFC 62

cross-border loan interest improperly reflected lack of security

The U.S. subsidiary (“CFC”) of an Australian company (“CAHPL”) in the Chevron multinational group borrowed in the U.S. commercial paper market at a borrowing cost of about 1.2% with the benefit of a guarantee from their ultimate U.S. parent, and on-lent U.S.$2.45 billion of such funds under an unsecured Australian-dollar credit facility to CAHPL at about a 9% interest rate. CAHPL deducted such interest in computing its income for Australian purposes, and received tax-free dividends from CFC of most of CFC’s profits (based on the 7.8% spread). The Australian Commissioners initially denied much of CAHPL’s interest deductions under a somewhat primitive Australian domestic pricing rule, and then later issued replacement assessments for most of the tax years based on an amendment which retroactively established an ability to assess where there was transfer pricing contrary to the Associated Enterprises Article of the relevant Treaty (here, Art. 9 of the Australia-U.S. Convention).

CAHPL’s appeal was dismissed. In his concurring reasons, Allsop CJ stated (at paras. 93-5) respecting the assimilated Art. 9 rule:

[W]ere CAHPL seeking to borrow for five years on an unsecured basis with no financial or operational covenants from an independent lender, in order to act rationally and commercially and conformably with the interests of the Chevron group to obtain external funding at the lowest possible cost consistently with any relevant operational considerations, it would do so with Chevron providing a parent company guarantee, if such were available.

In the light of the evidence as to Chevron’s policy concerning external funding and its willingness to provide a guarantee to achieve that end the above is the natural and commercially rational comparative analysis when one removes the controlled conditions operating between CAHPL and CFC and replaces them with the condition of mutual independence.

In the circumstances there would have been a borrowing cost conformable with Chevron’s AA rating, which, on the evidence, would have been significantly below 9%.

Somewhat similarly, Pagone J (speaking for himself and Perram J) stated (at para. 156):

[W]hat might be expected to operate between independent enterprises dealing wholly independently with each other was a loan by CAHPL with security provided by its parent at a lower interest rate.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 247 - New - Subsection 247(2) cross-border loan made on arm’s length terms would have benefited from a parent guarantee or other security 640
Tax Topics - Statutory Interpretation - Retroactivity/Retrospectivity retroactive tax was constitutional if it could be judicially challenged based on the facts 448

Sifto Canada Corp. v. The Queen, 2017 TCC 37

agreement with the U.S. competent authority re a VDP-adjusted transfer price binds CRA even if it had not yet audited the taxpayer

As a result of disclosures made by the taxpayer (“Sifto”) under the voluntary disclosure program, CRA reassessed Sifto’s returns for 2002 to 2006 to include additions to its income that would correspond to sales of Sifto’s products (rock salt) to a U.S. affiliate (“NASC”) at a higher transfer price than, in fact, was used. CRA did not audit SIfto prior to so reassessing. Sifto then applied to the Canadian competent authority (the “CCA”) and Compass (the U.S. indirect parent of Sifto and of NASC, which included NASC’s results in its consolidated returns) applied to the U.S. competent authority (the “USCA”) for relief from double taxation under Articles IX and XXVI of the Canada-U.S. Income Tax Convention. Two MAP agreements between the competent authorities resulted: the initial one; and a second approximately a year later that included 2002 (which the USCA had initially treated as being out of time for relief.) CRA advised Sifto’s counsel of the MAP agreements by letter, and Sifto accepted the terms of the agreements by letter (the “Letters”). However, CRA then audited Sifto and reassessed it on the basis that the transfer prices should have been higher than as reflected in the voluntary disclosure. CRA asserted that the MAP proceedings did not result in binding agreements between Sifto and CRA and, even if they did, they did not fix the arm’s length transfer price – so that CRA was not only authorized, but was required, by the ITA to issue the post-audit reassessments once in possession of the new audit information.

In rejecting this position and before directing the Minister to reassess consistently with the MAP agreements, Owen J found (at paras 105, 125-6):

…[T]he Letters reflect the Minister’s and IRS’s agreement that the adjustments to the Appellant’s and Compass’s income set out in the Letters are in accordance with paragraphs (1) and (3) of Article IX of the Convention respectively. To suggest that the MAP agreements simply addressed double taxation of Compass ignores the factual context in which the agreements were reached by the Minister and the IRS through their respective representatives. …

…[I]n a letter from the USCA to Compass dated January 25, 2011 … the USCA states:

… A mutual agreement has been reached regarding the transfer price of the transaction between Compass and...Sifto….

… This correctly recognizes that the adjustments to income allowed by paragraph (1) of Article IX of the Convention are the result of a transfer price and that it is impossible to agree to the adjustments to the Appellant’s income without also agreeing to the implicit transfer price that yields those adjustments.

After finding (at para. 142) that the Letters gave rise to a binding agreemetn which the Minister could not resile from as it was not "indefensible on the facts and the law," Owen J went on to find (at para 159) that, in any event:

…[S]ubsection 3(2) of the CUSTCA [the Canada-United States Tax Convention Act, 1984] gives paramountcy to the provisions of the Convention when they are inconsistent with the provisions of the ITA. In this case, the power of the Minister to further reassess the Appellant under the ITA is inconsistent with the power of the CCA and the USCA to resolve cases by mutual agreement under Article XXVI of the Convention. Accordingly, the effect of the provisions of the Convention must be given paramountcy over the effect of the provisions of the ITA.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 247 - New - Subsection 247(2) TNMN method was reasonable 205
Tax Topics - Income Tax Act - Section 115.1 - Subsection 115.1(1) 115.1 not germane to subsequent inconsistent CRA assessment 197
Tax Topics - Income Tax Act - Section 152 - Subsection 152(1) MAP agreement concurred in by taxpayer was binding on the Minister as it was not “indefensible” 255

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

5-year limitation did not apply to secondary Part XIII assessment

FCA appeal settled.

The taxpayer sold receivables to its Luxembourg parent (MIH) at over twice the discount which could be supported under s. 247(2)). CRA assessed the taxpayer to reduce its income under Part I within the five-year period referred to in Art. 9, para. 3 of the Canada-Luxembourg Treaty but did not assess the taxpayer for failure to remit Part XIII tax on the correlative s. 214(3)(a) benefit to MIH until beyond the five-year period. Boyle J found that this assessment under s. 215(6) was not barred by Art. 9:

  • It was questionable whether it represented a change by Canada of MIH's income, or constituted Canada seeking to add a transfer pricing adjustment amount to MIH's income and tax that increased amount. S. 215(6) instead represented an enforcement and collection provision.
  • While the amount of MIH's taxable benefit and deemed dividend might be the same as the transfer pricing adjustment to the taxpayer, it is not an amount of income that, had there been an arm's length discount rate, would have accrued to MIH. On the contrary, it was income that but for the non-arm's length terms and conditions would have accrued to the taxpayer.
Locations of other summaries Wordcount
Tax Topics - General Concepts - Evidence expert reports without testimony 46
Tax Topics - General Concepts - Purpose/Intention tax purpose v. commercial result 78
Tax Topics - Income Tax Act - Section 247 - New - Subsection 247(2) terms adjusted within framework of transaction chosen by taxpayer 894
Tax Topics - Income Tax Act - Section 247 - New - Subsection 247(4) advocacy 3rd-party report not read by taxpayer 149

Teletech Canada, Inc. v. Canada (National Revenue), 2013 DTC 5110 [at 6090], 2013 FC 572

After the taxpayer's U.S. parent (TeleTech US) determined that it had undercharged the taxpayer for administrative services provided in 2000-2002, TeleTech US filed amended returns with the IRS to increase its taxable income for those years, and the taxpayer requested CRA (on May 5, 2004) to make a corresponding downward adjustments for those years - which was withdrawn in March 2006 in order to clear the way for a request made of CRA (on May 11, 2006) under Art. IX of the Treaty for relief from double taxation, along with a similar request to the IRS. CRA denied the request in November 2006 as neither CRA nor the IRS (as contrasted with the taxpayers) had taken any action that resulted in taxation not in accordance with the Treaty.

CRA was informed by the IRS in December 2006 that TeleTech US's amended 2000-2002 returns had been assessed as filed and was invited to participate in a mutual agreement procedure under Art. 26. CRA did not respond, or inform the taxpayer of this letter.

Following an IRS audit of TeleTech US's amended returns, in July 2008 the IRS disallowed all of the increased income adjustment for 2000, and allowed only U.S.$11.2 million of the requested upward income adjustments for 2001 and 2002. However, the taxpayer did not renew its request with CRA for competent authority assistance until December 2009.

Following the CRA's denial of this request on June 9, 2011, the taxpayer applied for an order of mandamus to compel CRA to accept its "continuing" application for competent authority consideration under Art. IX and to submit the matter to arbitration under Art. XXVI.

MacTavish J found that CRA's denials on November 10, 2006 and June 9, 2011 of the taxpayer's application were clearly decisions which could only have been challenged by an application for judicial review made within 30 days thereafter (as required under s. 18.1(2) of the Federal Courts Act), which was not done (paras. 48, 50) - and the taxpayer's argument that CRA erred in requiring that there be government action before competent authority proceedings could be engaged represented an impermissible collateral attack on the first decision (paras. 55-56). As for the taxpayer's request, which was for an order of mandamus, she stated (at para. 61) "the Courts will not generally make an order of mandamus to compel a decision maker to make a particular decision where the decision-making power is discretionary."

Finally, the taxpayer's argument, that it was unreasonable for CRA to state that the taxpayer's second application to it was not timely in light of its not responding after receiving the IRS letter in December 2006 letter, also represented an impermissible collateral attack on the CRA's second decision (para. 72).

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

Pizzitelli J. found (at [paras. 102-103) that the limitation periods in Articles IX(3) and XXVII(3) of the Canada-Barbados Tax Treaty did not apply because the taxpayer was a Barbados International Business Company, which Article XXX expressly excludes from application of the Treaty. He also noted (at para. 104) that given that Article IX(2) and (3) dealt specifically with transfer pricing adjustments "one must question the applicability of another, more general limitation period found in a different part of the Treaty, such as Article XXVII(3), especially where that other limitation period is similar."


Matias Milet, Jennifer Horton, "The Canada Revenue Agency’s Interpretation of the 2017 OECD Transfer Pricing Guidelines", International Tax (Wolters Kluwer CCH), No. 103, December 2018, p.10

The OECD 2017 Transfer Pricing Guidelines reoriented transfer pricing towards the concept of value creation, namely, of ensuring that profits are taxed where economic activities take place and value is created. This represents a significant departure from the Canadian jurisprudence, which generally respects the legal substance of arrangements rather than recharacterizing them in accordance with their underlying economic substance.

The 2017 Transfer Pricing Guidelines also essentially proposed that, in order to compare an (actual) transaction between associated enterprises with a comparable transaction entered into between independent parties, the actual transaction must be first "accurately delineated" in light of "economically significant characteristics," e.g., the conduct of the associated parties, the functions they perform, the assets they actually use and the risks they actually assume.

If an analysis of the above enumerated economically significant characteristics results in a delineation of a transaction that differs from that entered into under the contract between the associated enterprises, the accurate delineation principle would then ignore the contractual transaction in the comparability analysis, instead focusing on the "accurately delineated" transaction. (p. 12)

As an example of this recharacterization approach (even where the criteria in s. 247(2)(b) are not both satisfied), the OECD’s recent Discussion Draft on Financial Transactions provides an example of a purported loan being “accurately delineated” as equity, chiefly because of a low likelihood of repayment within the specified term.

In this context, it is problematic that the 2018 CTF Roundtable, Q.4 indicated that CRA will apply the 2017 Transfer Pricing Guidelines to pre-2017 taxation years, as well as to the interpretation of treaties entered into post-2017. CRA does not consider such an application to be retroactive, due to CRA’s characterization of these Guidelines as merely an elaboration on the prior OECD guidance.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 247 - New - Subsection 247(2) 649

Mateusz M. Krauze, "Impact of Cloud Computing on Permanent Establishments Under the OECD Model Tax Convention", Tax Management International Journal, Vol. 44, No. 3, March 13, 2015, p. 131.

Categories of Cloud-based services (p.132)

The models for providing cloud-based services have traditionally been divided into three categories: Software as a Service (SaaS), Platform as a Service (PaaS) and Infrastructure as a Service (laaS). SaaS offers ready-made applications for end-users. PaaS is more like an operating system, such as Microsoft Windows Azure, which allows the client to design applications with appropriate programming tools. ...

[I]ntegration Platform as a Service (iPaaS)… is a cloud integration platform, enabling connectivity to SaaS and other cloud services, and it offers a platform for SaaS users and cloud vendors to build and host packaged integration solutions which ensure that the data provided is available in a synchronized fashion across mobile, social and online mechanisms….

Disguised transfers of intangibles while under the Cloud (p.143)

[i]n the cloud it might be relatively easy to conceal a number of intangibles which would normally have to be transferred independently, especially if they are disguised as part of the overarching cloud infrastructure rather than as individual components transferred .within it….

[I]f more than just one intangible is transferred between S1 and S2 [two subs] while they are under the iPaaS "umbrella" it will be virtually impossible to evaluate each transfer separately because all of them will be integrated by the iPaaS and are also likely to derive most, if not all, of their functionality from being integrated by it. This difficulty will then trickle down to the next level affecting the choice of differing tax treatments of the respective individual subtransactions….

See also summary under Treaties – Art. 5.

Locations of other summaries Wordcount
Tax Topics - Treaties - Income Tax Conventions - Article 5 281

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.

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.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 247 - New - Subsection 247(2) 892

Robert Couzin, "Policy Forum: The End of Transfer Pricing?", Canadian Tax Journal, (2013) 61:1, 159-78, at 172

After noting (at p. 171) that "the arm's length principle...tries to hypothesize its way around the economic integration of the firm," he stated:

Treating the firm's constituent and inextricable parts as if the composite entity were merely the sum of discrete transactions and dealings between independent actors is not a mere peccadillo. Ignoring the "firmness" of the firm has serious consequences. It not only fails to address directly the value of integration; equally important, it ignores the inescapable fact that many activities, relationships, and transactions occur within an MNE but never outside one.

A symptom of this latter problem appears in the recognition of 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.

Veronika Solilová, Marlies Steindl, "Tax Treaty Policy on Article 9 of the OECD Model Scrutinized", OECD, Bulletin for International Taxation, March 2013, p. 128, at 130

In the course of reviewing the background to Article 9(2) of the OECD Model Convention, they stated:

…According to Working Party 7, article 9 of the OECD Draft (1963) "serves a useful purpose as a statement of what Contracting Parties to Double Taxation Conventions have in Mind". From this statement, it may be concluded that the contracting states even intended to cover economic double taxation arising as a result of adjustments envisaged in article 9(1) of the OECD Model. Consequently, it is assumed that the contracting states had to make a corresponding adjustment, even without the inclusion of a separate provision for this. However, the United Stated initiated a targeted campaign with the intention of creating an international consensus relating to rules on corresponding adjustments. Accordingly, the second report of Working Party 7 resulted in a recommendation that the OECD Model provide for a corresponding adjustment to be made in all cases where profits had to be reallocated to one contracting state and where that state and the other contracting state agreed that the reallocation was fair. As the Committee agreed with the recommendation, article 9(2) was added to the OECD Model (1977). Against this background, however, if may be assumed that article 9(2) of the OECD Model is crucial with regard to the obligation to make a corresponding adjustment and, therefore, to prevent legally arising economic double taxation. In light of the amendment to the Commentary on Article 9 of the OECD Model (1992), such reasoning can, however, be disproved.…

Michael C. Durst, "OECD's Fight Against Income Shifting - and for Its Global Role", Viewpoints, Tax Notes International, 3 December 2012, p. 933

In a further discussion of the OECD Discussion Draft on Transfer Pricing for Intangibles, he notes (at p. 935) that "transfer pricing rules — like the U.S. cost-sharing regulations — that permit the shifting of income-generating opportunities to affiliates based on the mere transfer of cash allow for the evisceration of a country's tax base through income shifting" (which he earlier referred to as amounting in the case of the US to perhaps $1.7 trillion) and refers to the fallacy that "transfers of intangibles between affiliates do not facilitate tax avoidance as long as the purchaser pays fair market value." He then states (at p. 935) that the OECD discussion draft combats these fallacies, as under its approach:

For a company to be treated as the earner of income from an intangible asset, the company must do something more than simply finance the development or purchase the asset. The OECD discussion draft proposes as this ‘‘something more'' a requirement that to claim the right to income from exploitation of an intangible, a taxpayer must, through active business activities, exercise control over the development and exploitation of the intangible.

Michael C. Durst, "'Risk' and the OECD Discussion Draft on Transfer Pricing", Viewpoints, Tax Notes International, 15 October 2012, p. 285

After noting (at p. 285) that "under properly constructed transfer pricing rules...controlled entities should be treated as bearing the same risks they would bear if they were independent entities dealing with other businesses at arm's length," he goes on to note (at p. 276):

In the context of transfer pricing practice, important classes of risk-apportioning business arrangements include: (i) ‘‘limited risk'' distribution arrangements (including, in some instances, consignment and commissionaire arrangements) by which a group member, typically in a low-tax country, engages with a distributor to sell a product to unrelated parties in return for a fee or other limited return so that any residual profits or losses will inure to the lowtax party; (ii) contract manufacturing or similar arrangements, in which a group member, again typically in a low-tax country, arranges for an affiliate to perform manufacturing on a cost-plus or similar basis, so that residual profit or loss from the sale of the resulting product inures to the low-tax party; and (iii) service arrangements, in which a group member, also typically in a zero- or low-tax country, engages an affiliate on a cost-plus basis to develop potentially valuable intangibles, with any profits from use of the intangibles inuring to the low-tax affiliate. Much international tax practice today centers on setting up arrangements of those kinds. Through those arrangements, multinational groups recently have succeeded in shifting billions of dollars of potentially taxable profits into low- and zero-tax jurisdictions.

David R. Jarczyk, "Info Services Firm Comments on OECD Draft Transfer Pricing Guidelines", Tax Notes International, 24 September 2012, p. 1221

Adresses the following "myths" respecting the application of the CUP and CUT methods to intangibles: the CUP method cannot be applied because perfect comparables do not exist; global market information is not available; and redacted licence agreements have no value.

Michael C. Durst, "The OECD Discussion Draft on Safe Harbors – And Next Steps", Viewpoints, Tax Notes International, 13 August 2012, p. 647

Respecting the discussion draft of the OECD's Working Party 6 recommending that the OECD adopt changes to its transfer pricing guidelines to envision that tax administrations develop safe harbour ranges of arm's-length margins and markups for use in benchmarking the incomes of relatively uncomplicated business operations conducted by members of multinational groups, Durst states (p. 647):

The discussion draft, in my view, responds in a sensible manner to some of the most common and serious practical difficulties that have arisen in transfer pricing practice over the past several decades. Attempting, over the years, to perform ‘‘from the ground up'' factual and comparables analyses for each individual business operation, regardless of its uniqueness or complexity has led to very large and in a great many cases prohibitive compliance costs. Despite the high costs incurred, however, the relative paucity of available comparables has caused comparable analyses to yield results that are too approximate and uncertain to be used by tax authorities in enforcement. [Footnote 2: These problems are demonstrated vividly by the deficient state of the contemporaneous documentation that taxpayers around the world are supposed to prepare to explain the detailed analyses that they are conducting. The head of transfer pricing at the OECD has observed that ‘‘transfer pricing documentation is some of the least informative literature that you will ever read.'' See ‘‘Andrus Favors Multilateral Approach to Safe Harbors, Simplified Documentation,'' Tax Mgmt. Transfer Pricing Rep. (Feb. 9, 2012)….]

Respecting paragraph 9 of the discussion draft, which states that countries might want to place some presumptive weight behind safe harbor ranges to facilitate enforcement, he states (p. 648):

Although this paragraph may seem discordant to some commentators, it must be remembered that transfer pricing rules are intended to constitute anti-avoidance tools for use in tax enforcement, and for anti-avoidance tools to be effective in practical application they must have some teeth. Long-standing experience has now made clear that requiring tax administrations to engage with taxpayers in case-by-case donnybrooks of detailed factual analysis, without the guidance of clear presumptions of some kind, simply is not realistic; requiring this approach has proven to be a recipe for tax anarchy rather than tax enforcement.

Michael C. Durst, "The OECD Discussion Draft on Transfer Pricing for Intangibles", Viewpoints, Tax Notes International, 30 July 2012, p. 447:

After quoting (at p. 448) the statement in the OECD discussion draft on transfer pricing for intangibles that "neither legal ownership, nor the bearing of costs related to intangible development... entitles an entity within an MNE group to retain the benefits or returns with respect to intangibles," Durst states:

For decades, many have apparently believed erroneously that under generally applicable principles of international tax law, bearing the financial costs of business activities entitles a party, for tax purposes, to income derived from those activities. That view is and always has been flatly incorrect. Working Party 6 already has performed a valuable service by correcting the apparently widespread misapprehension of this important point.

After stating (at p. 449) that "the discussion draft may be allowing a serious loophole in suggesting without additional clarification that control of R&D or other intangibles-creating activities can entitle a company to the residual income generated from successfully created intangibles," he states (at p. 450):

For a high-end contract R&D service provider, which has the sophistication required to develop potentially highly valuable intellectual property, to agree to do so for only fixed compensation would place the R&D provider at great economic risk. That R&D provider probably will demand a share in future income from developed intangibles as part of the compensation under its contracts. Indeed, it seems unlikely that for intangibles of potentially high value, contracts in which the party purchasing R&D services receives full residual rights to developed intangibles exist at arm's length....

Similarly, he states (at p. 450) that "the discussion draft gives the appearance — perhaps unintended — of acquiescing in the notion that when one related entity exercises control and another performs the actual intangibles-creating activities, the presumptively most reliable transfer pricing method under the arm's-length principles is for the party exercising control to retain the residual right to income from the resulting IP," and makes the following suggestion (also at p. 450):

If the arm's-length principle is to be applied properly, the relative contributions of those managing and those implementing intangibles-creating activities need to be determined so that an arm's-length division of income between the two can be determined. The best indicator of that arm's-length division of income normally will be the relative values that the multinational group itself places on the managers and on the implementers — that is, the relative values of their compensation. To prevent a continuation of massive income shifting through one-sided apportionments of income to entities where managerial functions are located, Chapter VI should make clear that in the absence of compelling evidence to the contrary, the relative compensation paid to personnel (including both managerial and operations personnel) performing services for the development of intangibles will be the most reliable indicator of the arm's-length division of income resulting from the successful exploitation of developed intangibles.

CRA Policy

3 June 2013 Memorandum 2012-0468131I7: The Rulings Directorate concluded that returns paid by the Canadian taxpayer (‘Canco") on "Contracts" issued to its wholly-owning non-resident parent ("ForParent") were deductible interest provided the rates reflected the arm's length standard referred to immediately below. It went on to note that if the conditions made or imposed between ForParent and Canco regarding the Contracts differed from those which would have been made between independent enterprises, i.e., the TSO determined that the returns did not reflect the commercial interest rates that prevailed between arm's length parties at the time the Contracts were executed, then a resulting reassessment of Canco would be subject to the time limitation contained in Article IX of the applicable Treaty.

CRA then noted that if a reassessment to deny the interest deductions of Canco instead were warranted because a Contract

were a commercially common instrument which would be classified as an equity investment even if it were entered into between independent enterprises, in our view, such a reassessment would not be subject to the time limitation period in [Article IX] because it would not be as the result of conditions made or imposed between the two enterprises in their commercial or financial relations which differed from those which would be made between independent enterprises.


Working Party No. 6 of the OECD Committee on Fiscal Affairs, Discussion Draft: Proposed Revision of the Section on Safe Harbours in Chapter IV of the OECD Transfer Pricing Guidelines and Draft Sample Memoranda of Understanding for Competent Authorities to Establish Bilateral Safe Harbours, 6 June to 14 September 2012:

8. A safe harbour in a transfer pricing regime is a provision that applies to a defined category of taxpayers or transactions and that relieves eligible taxpayers from certain obligations otherwise imposed by a country's general transfer pricing rules. A safe harbour substitutes simpler obligations for those under the general transfer pricing regime. Such a provision could, for example, allow taxpayers to establish transfer prices in a specific way, e.g. by applying a simplified transfer pricing approach provided by the tax administration. Alternatively, a safe harbour could exempt a defined category of taxpayers or transactions from the application of all or part of the general transfer pricing rules....

9. Other alternative formulations are also possible. For example, a rebuttable presumption could be established under which a mandatory pricing target would be established by a tax authority, subject to a taxpayer's right to demonstrate that the target price is inconsistent with the arm's length principle when applied in the taxpayer's case. It would be essential in such a system to permit resolution of cases of double taxation arising from application of the mandatory pricing target through the mutual agreement process....

34. Safe harbour provisions may raise issues such as potentially having perverse effects on the pricing decisions of enterprises engaged in controlled transactions and a negative impact on the tax revenues of the country implementing the safe harbour as well as on the countries whose associated enterprises engage in controlled transactions with taxpayers electing a safe harbour....

35. However, in cases involving smaller taxpayers or less complex transactions, the benefits of safe harbours may outweigh the problems raised by such provisions. Making such safe harbours elective to taxpayers can further limit the divergence from arm's length pricing. Where countries adopt safe harbours, willingness to modify safe-harbour outcomes in mutual agreement proceedings to limit the potential risk of double taxation is advisable....

38. For more complex and higher risk transfer pricing matters, it is unlikely that safe harbours will provide a workable alternative to a rigorous, case by case application of the arm's length principle under the provisions of these Guidelines.

The discussion paper appends draft memoranda of understanding that competent authorities for two countries might use in establishing safe harmours governing three situations: low-risk manufacturing operations; low-risk distribution operations; and low-risk research and development services.

Working Party No. 6 of the OECD Committee on Fiscal Affairs, Discussion Draft: Revision of the Special Consideration for Intangibles in Chapter VI of the OECD Transfer Pricing Guidelines and Related Provisions, 6 June to 14 September 2012:

Working Party No. 6 delegates are uniformly of the view that transfer pricing outcomes in cases involving intangibles should reflect the functions performed, assets used, and risks assumed by the parties. This suggests that neither legal ownership, nor the bearing of costs related to intangible development, taken separately or together, entitles an entity within an MNE group to retain the benefits or returns with respect to intangibles without more. (Boldface inset before para. 27)

54. In summary, for a member of an MNE group to be entitled to intangible related returns, it should in substance:

  • Perform and control important functions related to the development, enhancement, maintenance and protection of the intangibles and control other related functions performed by independent enterprises or associated enterprises that are compensated on an arm's length basis;
  • Bear and control the risks and costs related to developing and enhancing the intangible; and,
  • Bear and control risks and costs associated with maintaining and protecting its entitlement to intangible related returns.

Where a party is allocated intangible related returns under contracts and registrations, but fails to perform and control important functions, fails to control other related functions performed by independent or associated enterprises, or fails to bear and control relevant risks and costs, the parties performing and controlling part or all of such functions and bearing or controlling part or all of such risks will be entitled to part or all of the intangible related returns.

136. Experience has shown that the transfer pricing methods most likely to prove useful in matters involving transfers of intangibles or rights in intangibles are the CUP method and the transactional profit split method. Valuation techniques can be useful tools in some circumstances.

138. In some situations, intangibles acquired by an MNE group from unrelated parties are transferred to a member of the MNE group in a controlled transaction immediately following the acquisition. In such a case the price paid for the acquired intangibles will usually (after any appropriate adjustments for acquired assets not re-transferred) represent a useful comparable for determining the arm's length price for the controlled transaction under a CUP method.

141. Where limited rights in intangibles are transferred in a licence or similar transaction, and reliable comparable uncontrolled transactions cannot be identified, a transactional profit split method often can be utilised to evaluate the respective contributions of the parties to earning combined income....

143. It is sometimes suggested that a profit split analysis can be applied to transfers of partially developed intangibles. In such an analysis, the relative value of contributions to the development of intangibles before and after a transfer of the intangibles in question is sometimes examined. Such an approach may include an attempt to amortise the transferor's contribution to the partially developed intangible over the asserted useful life of that contribution, assuming no further development....

144. It is unlikely that such approaches will readily yield a reliable estimate of the contributions of the parties to the creation of income in years following the transfer. In such an analysis, a variety of difficult to evaluate factors would need to be taken into account.