CRA Notice to tax professionals 5 July 2019

Hybrid mismatch arrangements are tax plans intended to secure a tax advantage within a multinational enterprise by exploiting differences in the tax treatment of the same financial instrument or entity between different jurisdictions. … CRA … has resolved a file regarding a hybrid mismatch arrangement involving the deduction of non-arm’s length interest in a series of transactions that included a forward subscription agreement (outlined in the diagram below) on the basis that paragraphs 247(2)(b) and (d) of the Income Tax Act and transfer pricing penalties applied.

It is the CRA’s general view that such transactions are undertaken primarily to obtain a tax benefit and that they would not be undertaken by parties dealing at arm’s length. When the CRA finds transactions similar to the example below, the Transfer Pricing Review Committee will be consulted regarding the application of paragraphs 247(2)(b) and (d). Where these paragraphs apply, related transfer pricing penalties will generally apply on the basis that taxpayers engaging in this type of tax planning did not use reasonable efforts to use arm’s length prices, terms and conditions in their transfer pricing.

CRA then provided a cryptic diagram which appeared to portray an arrangement under which Canco borrows, say, $100M from U.S. parent (a C Corp) at, say, 10% interest and funds the cash interest payments of $10M p.a. through the receipt of those sums as prepayments under agreements for the forward sale of treasury shares by it to a U.S. LLC subsidiary of U.S. parent (which, in turn, funds the payments by LLC under the prepaid forwards by annually contributing $10M to LLC).

CRA provided a cryptic diagram portraying a borrowing by Canco of, say, $100M from U.S. parent (a C Corp) at, say, 10% interest, with Canco funding the cash interest payments of $10M p.a. through the receipt of those sums as prepayments under agreements for the forward sale of treasury shares by it to a U.S. LLC subsidiary of U.S. parent (which, in turn, funds the payments by LLC under the prepaid forwards by annually contributing $10M to LLC). This arrangement presumably was targeted to not generate interest income in the U.S., and an interest deduction to Canco.

After noting that it had “resolved a file regarding a hybrid mismatch arrangement involving the deduction of non-arm’s length interest in a series of transactions that included a forward subscription agreement (outlined in the diagram …) on the basis that paragraphs 247(2)(b) and (d) … and transfer pricing penalties applied,” CRA stated:

It is the CRA’s general view that such transactions are undertaken primarily to obtain a tax benefit and that they would not be undertaken by parties dealing at arm’s length. When the CRA finds transactions similar to the example …, the Transfer Pricing Review Committee will be consulted regarding the application of paragraphs 247(2)(b) and (d). Where these paragraphs apply, related transfer pricing penalties will generally apply on the basis that taxpayers engaging in this type of tax planning did not use reasonable efforts to use arm’s length prices, terms and conditions in their transfer pricing.