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.
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