27 March 2019 CTF Seminar - Transfer Pricing

This summarizes some of the remarks and answers of Alexandra MacLean (Director General, International and Large Business Directorate, CRA) at a seminar of the Canadian Tax Foundation held in Toronto on 27 March 2019 on transfer pricing. The moderator was Sébastien Rheault (Barsalou Lawson Rheault), and the other panelists were Matt Billings (Duff & Phelps), Alex Ho (Manager, International Tax Division, CRA), Michelle Levac (CRA), Al Meghji (Osler), Angelo Nikolakakis (EY Law), Donna O'Connor (Director, Competent Authority Services Division, CRA), and Sue Wooles (BMO Financial).

CRA conformity with OECD transfer-pricing Guidelines

The government’s official position, as mentioned at other events, is that the transfer-pricing rules in s. 247 are consistent with the OECD Guidelines. That has been hotly debated in some parts of the tax community, but we should consider where those arguments could take us.

It may well be that, in an individual file before the Tax Court of Canada, drawing distinctions between s. 247 and the guidelines may help lead to better outcomes, but it’s hard to see how it would be good for the Canadian tax system, or for multinationals in general, to deal with wedges driven between the two regimes.

In other words, be careful what you wish for.


Competent Authority Services Division (CASD)

The division has seven sections:

  • MAP-APA Sections 1-4;
  • Exchange of Information Services Section 1-2; and
  • MAP Technical Cases Section.

The first four are most pertinent to today’s transfer-pricing topic. Those are divided by which set of countries they deal with.

Effective April 1st, Exchange of Information Services is moving to a different Directorate, so CASD will soon focus exclusively on MAP and APA matters. Exchange of Information is moving to Offshore and Aggressive Tax-Planning, except that that Directorate will on April 1st be renamed to the “High Net-Worth Income Tax Directorate.”

Principal purpose test (PPT)

Rulings is looking at how the PPT will be applied in Canada. It has been suggested that the test resembles the tests in Canada’s general anti-avoidance rule, but that question is not an immediate concern for Audit – we have not started working on 2017 yet.

Downward adjustments

We are looking at our policy on downward adjustments. S. 247(10) states that the Minister shall not make a downward adjustment unless it is “appropriate in the circumstances,” which is an order of magnitude more vague than s. 247(2)(b).

Question: What are the key drivers for CRA to exercise its discretion for downward adjustments?

MacLean: The basic idea is that we want to avoid double-non-taxation, so any kind of base-erosion scheme would not be “appropriate in the circumstances.”

We would want to see good evidence that there is some corresponding upward adjustment, and that we are respecting the arm’s length principles (whatever those might be), and that we are avoiding both double-taxation and double-non-taxation.

Codifying those principles can be tricky – I understand why the drafters went with “appropriate in the circumstances.”

Ultimately, conclusions are easier to reach when we have all the facts and circumstances in front of us.

Question: Under what circumstances will the International Tax or Audit Division forward the request for downward adjustment to the Competent Authority Services Division. Can you elaborate on that?

MacLean: We have concluded that those referrals should be made where there is a treaty country on the other side of the transactions in issue. Our thinking is that CASD already has policies that capture, as clearly as possible, what we mean by “appropriate in the circumstances.” In other words, we see such a referral to CASD as a routine step, not a momentous one.

If there’s no Treaty country on the other side, then the taxpayer is dealing with Audit, and will generally have to demonstrate that the proposed downward adjustment would not lead to double-non-taxation.

Transfer Pricing Review Committee (TPRC)

Billings: How can taxpayers deal with their contemporaneous documentation so that it will provide them protection if CRA recharacterizes their transactions?

MacLean: We don’t really run into situations where CRA’s use of s. 247 thwarts a taxpayer’s conscientious attempts to document their transactions. In practice, if we are prepared to recharacterize under paras. (b) and (d), we are tacitly finding that the taxpayer’s documentation of the transaction is willfully dishonest.

The test under 247(3) is not just about documentation. The test is whether the taxpayer has made “reasonable efforts” to determine and apply arm’s-length prices. If CRA is proposing a recharacterization, it means we don’t think the taxpayer made reasonable efforts to use arm’s-length prices, but rather extraordinary efforts to use non-arm’s-length prices.

Wooles: What is the composition of the TPRC, when are taxpayers made aware that the Committee is looking into them, and are they allowed to make representations beforehand?

MacLean: The TPRC is chaired by the Director of the International Tax Division, and its members include all the managers in that division, and representation from Justice. Most TPRC meetings concern s. 247(3), and some concern s. 247(4), which are deeming rules that could put the taxpayer in penalty territory. That’s a “vanilla” TPRC meeting.

Recharacterization, on the other hand, is a three-step process. Alex Ho can explain.

Ho: At the first stage, our audit staff look at a transaction and find that there might be a possibility of recharacterization. They make a submission to the TPRC. If the submission is accepted, the taxpayer is notified. The audit team then conducts more research on the matter, provided the facts allow the taxpayer to have a discussion on that process.

At the second stage, a second submission goes to the TPRC, and a second review determines whether the auditor should be able to propose an adjustment under s. 247(2)(b) and (d). The taxpayer is then notified and allowed to make a submission on that.

At the third stage, the TPRC meets, along with representatives from Justice, Abusive Tax Avoidance, and Finance, to make a final determination.

MacLean: To be clear, we are describing how recharacterization can happen at the audit stage. Back in the Income Tax Act itself, recent amendments make it clear that assessing positions can also be added later in the process. Appeals Branch and the Department of Justice also have a certain amount of latitude in applying s. 247.

My main point is that auditors work closely with Headquarters when dealing with transfer-pricing issues. The recently circulating concept of a “soft recharacterization,” where an auditor makes an end-run around Headquarters by making recommendations that merely emulate the substance of a recharacterization, is not very realistic.

Test in s. 247(3)

Rheault: A taxpayer can satisfy s. 247(4) and still run afoul of s. 247(3). Can you comment on this?

MacLean: The test in s. 247(3) is whether the taxpayer made reasonable efforts to use arm’s-length prices. In a lot of cases, it’s clear that they have. The test isn’t about the page-count of your documentation. If the disagreement is on the scale of basis-points, and you’re not running afoul of s. 247(4), you’re probably in pretty good shape. The more aggressive the transfer price, the less likely it is that you have made reasonable efforts.

Country-by-Country (CbC) reporting

MacLean: Canada has committed to the “appropriate use” of CbC reporting. “Appropriate” means it is used to assess risk in transfer-pricing and other BEPS-related matters. A CbC report alone does not itself contain enough information to support a transfer-pricing adjustment. Auditors need to take particular training before they are allowed to access the CbC report.

CbC reporting is coming up for review in 2020. Delegates are meeting this spring on how to structure the 2020 review. The “aggregated v. consolidated” issue will be discussed – whether a taxpayer’s file should contain each country’s information separately, or be integrated into a single report.

Communiqué on Tax Accrual Working Papers

MacLean: On the subject of obtaining taxpayer information for audit purposes, a new communique went out to Audit yesterday, and we intend to publicize it soon (it would be available under Access to Information anyway, so we may as well help the process along).

In summary, we think BP is not a complete bar to access tax accrual working papers. The Communiqué puts some conditions around it – reasonableness and restraint. It says that we don’t always need to see the analysis behind transactions; what we really need is the facts. We need to be able to determine the purpose of the transaction, which is sometimes relevant under s. 247, and always relevant for s. 245.

If we are satisfied that we understand the facts of the transaction and purpose of the transaction, we will make up our own minds as to the legal effects of the transaction. Therefore, if you have your legal analysis nicely segregated from the relevant facts, then those facts may be all we need.

We also require Headquarters to be notified if auditors are seeking tax accrual working papers.

Wooles: Can you provide anything related to the volume of information requested, and the corresponding burden on the taxpayer?

MacLean: Some of the paper favors taxpayers and other parts of it bolsters CRA.

Tax accrual working papers are the core of the Communiqué. It incorporates BP. It takes a look at recent jurisprudence and what it actually means. Atlas is also incorporated (briefly, it states that BP is not a complete shield for all requests for taxpayer information, and taxpayers can’t just assert solicitor-client privilege over every type of document and expect the Minister to abide by that).

It is also about more than just TAWPs. I do think CRA needs to act reasonably, and we need to have a reasonable suspicion that the information in question is relevant. Of course, the audit business is tricky, and we don’t know what we don’t know. We can’t just blithely accept taxpayer assertions that nothing interesting is going on in, e.g., 8000 pages of financial records, even if that assertion later proves true. I have a lot of sympathy for people on both sides of this process.

Dispute resolution

MacLean: There is also a new Communiqué about audit agreement policy. It’s still based on principles rather than hard-and-fast rules. Most of you will be familiar with the relevant line of cases – essentially we cannot administer the tax rules contrary to the tax rules.

Rosenberg, 2016 FC 1376, is mentioned. One thing it stood for is the idea that, yes, the Minister has to respect the tax laws, but there is a reasonableness requirement. There are about 2000 pages of tax rules, and you have to come to some conclusion on a file; so there’s a kind of de minimis quality about that. Rosenberg also stands for the principle that, if you reach an agreement with the Minister, the Minister should stand behind it. CRA lost that one, but I think the principles coming out of it were good ones.

One issue in the transfer pricing context at the audit stage is MAP rights – how many kicks will the taxpayer get at this, and why should Audit go out of its way to try to resolve something if it’s not a final resolution? We have taken a look at that situation. MAP rights cannot be waived, as a legal matter, but we have entered into a settlement recently where the taxpayer stated their intention not to proceed with the MAP process, and the agreement is premised on the truth of that statement, so that the agreement would not bind the Minister if the taxpayer repudiated.

We have founded the Audit File Resolution Committee. It is modelled loosely on the GAAR Committee, having representation from Justice and Rulings but not Finance. The Committee considers taxpayer proposals to resolve a file at the audit stage. Not every file will be resolved this way – one of our criteria is that the adjustment in question must be at least $100 million. In those situations, the Committee will look at the proposal, and recommend acceptance, rejection, or a counter-proposal.