CRA goes along with new OECD transfer-pricing policy of overriding the legal characterization of transactions
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.
As an example of this recharacteriazation 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 Rouundtable, 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.
Neal Armstrong. Summary of Matias Milet and 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 under s. 247(2).