3 February 2021 Transfer Pricing Conference

This summarizes CRA responses at the transfer-pricing webinar hosted by the Canadian Tax Foundation on February 3, 2020, made during the "Panel I: Transfer Pricing Audits and Competent Authority" segment, and also appends Audience questions and responses that were provided at the end of the 2nd Panel on "Transfer Pricing Update Appeals Branch" (but mostly related to Pane I). The CRA presenters during Panel I were:

Isabelle Brault, Director, Competent Authority Services Division
Michael Jennings, Director, International Business Division
Alexandra MacLean, Director General, International and Large Business Directorate

The moderator was Sébastien Rheault (Barsalou Lawson Rheault). Also presenting was Amanda Heale (Blakes). Matt Billings (Duff & Phelps) managed the Q&A session.

CRA’s priorities in combatting tax avoidance

Rheault: In the Fall Economic Statement, the government announced over $600 million of additional funding over five years to combat tax avoidance. What are the priorities of International and Large Business Directorate (ILBD) for the 2021-22 cycle?

MacLean: Some of our priorities are continuous, such as training and recruiting for expanded tax and technical expertise, and the new funding has an impact on that. ILBD is in charge of some of the advanced training.

As for changes, we are working on the wage subsidy program, and transitioning the Large Business Audit Division away from face-to-face interactions and towards virtual interactions. This includes telework and improving our ability to receive documents electronically and communicate with taxpayers electronically. Also on the technical side are the continuing improvements to our risk-assessment tools, which improve our ability to select files.

There is also our “audit currency” goal, which relates to getting through audits more quickly and efficiently. Given our overall objections and dispute rate, this often entails having discussions around disagreements at an earlier point in the file where possible, and thereby arrive at a resolution faster – whether that involves litigation, settlements, or even sometimes getting taxpayers to agree with our position.

Rheault: Are the document-submission changes permanent?

MacLean: I think we are not going back to paper-based processes.

We are somewhat pleasantly surprised by how much we are getting done using these tools which no one was using pre-pandemic. We are optimistic that that can save time and resources, both on our side and the taxpayer’s. For instance it’s much easier to schedule a two-hour discussion without worrying about travel logistics.

Cancellation of IC 87-2R “International Transfer Pricing”

Rheault: Why has CRA cancelled IC 87-2R?

MacLean: When I worked at the International Tax Division, I was told that everyone knew that IC 87-2R was out of date, had been superseded by TPMs, and was really just a trap for inexperienced practitioners.

Two key problems with IC87-2R are its treatment of recharacterization as a “last resort,” and the order in which it applies s. 247 in relation to other provisions of the Act.

Jennings: We have not officially ruled out an update to IC 87-2R eventually, but it is not a priority. We are focusing instead on updating our transfer pricing memoranda. TPM-2, on secondary adjustments and repatriation, is in its final stages of approval. We are also working on TPM-3, dealing with downward adjustments, in conjunction with updates to IC 71-17, Guidance on Competent Authority under Canada’s Tax Conventions.

International audit update

Recent hirings

Rheault: The Directorate has made a number of appointments recently from the private sector. Is this a structured effort?

MacLean: I wouldn’t call it a “structured effort,” but neither would I call it haphazard. We find that our work benefits from a diversity of perspectives.

Tax in general, and transfer pricing in particular, are very multi-disciplinary so we’ve been interested in having a few more lawyers join the team. CRA is well endowed with accountants, so having more people with legal or economics training complements that. It’s good to get a private sector perspective, and it’s also great to have career employees who understand what makes the Agency tick.

Status of international audits

Jennings. Early in the pandemic, our audit activities were put on hold initially and we were focused on files with significant compliance issues, major milestones approaching such as statute barred dates, treaty barred dates, or resulting from a taxpayer request.

Since the end of June, the CRA has moved back to business as usual, and has been continually equipping auditors to work fully from home. At this point, all audit activities in the International Large Business programs have resumed, with a focus on the highest-risk files identified in our risk-assessment systems.

Update on CbC exchanges

Jennings. We work closely with Exchange of Information on obtaining the information through CbC reporting. We have approximately 200 ultimate parent entities here in Canada that have filed these CbC reports. Canada also has about 1,500 entities that are with partner jurisdictions (that would be our subsidiary entities here in Canada that have a parent filing in another country).

Canada has agreed with, and continues to abide by, the appropriate use criteria that were established by the various jurisdictions that adopted CbC reporting at the time. Those criteria limit the use of this information to high-level transfer-pricing risk-assessment (i.e. for base-erosion and profit-shifting), and also for use for economic and statistical analysis.

We have various risk-assessment systems, tools, and algorithms to help us identify the highest-risk entities that we would like to focus on in our work plans, so that we use the CbC information at that high-risk level nationally. The information can also be used again for the more detailed field risk-assessment in audits when auditors are preparing their audit plans, but field-use of CbC information is usually restricted, and the International Tax Division provides guidance to ensure that it is used properly.

An example of statistical and economic analysis is the OECD’s report on corporate tax statistics, published in July 2020, in which Canada and 26 other jurisdictions provided sanitized and aggregated information for that report.

Competent Authority Services Division

MAP/APA target times

Rheault: Can you tell us about CASD’s internal target-times?

Brault: Current target times are consistent with the OECD guidelines for bilateral APAs (within 48 months), and MAP cases (within 24 months). CASD has made pandemic-related workflow changes similar to those described above for ILBD, so I do not expect any significant impact on our completion-rates.

MAP/APA harmonization

Has CASD given any thought to harmonizing APA and MAP papers relating to the same matter?

Brault: If an APA submission is received and the issues in the APA years are the same as those being raised in respect of MAP years, then I would ask CASD to develop a position paper for both the APA and the MAP together so that we could present it to the treaty partner at the same time.

CASD not sharing APA papers with taxpayer

Rheault: CASD has stopped sharing a copy of its APA paper to the taxpayer for comments before sending it to a treaty partner. Would CASD consider giving the taxpayer an opportunity to comment for, e.g., fact-checking?

Brault: I would not expect a change in that policy. The APA paper reflects the exchanges between the tax administrations. If there are any differences in the understanding of the facts between the competent authorities which could be of concern, then of course we will ask the taxpayer for clarification or confirmation of our understanding.

In light of the increasingly tight deadlines for resolving cases, it is important that the taxpayer properly describe the facts from the outset.

ICAP progress

Rheault: Does CRA have an update on completed cases for ICAP (International Compliance Assurance Programme re multilateral collaboration from the start of a risk assessment exercise) and ICAP 2.0?

Brault: The CRA is currently part of three ICAP 2.0 risk assessments – one is complete and two are still in progress. The pandemic has delayed the current ICAP round, as announced in December just before the holidays.

The Forum on Tax Administration generally agreed to ramp up the work on tax certainty, but also announced that ICAP was moving from a pilot phase to an established program. The Handbook is being updated and is set to be released in March 2021. The intent is to have an updated list of ICAP countries by June, and the deadline for submissions of October 1, 2021.

Draft IC 71-17 (re Competent Authority assistance)

Status of IC 71-17

Rheault: What is the status of IC71-17, on competent authority assistance?

Brault: The document is in final stages of approval – it should hopefully be ready in weeks rather than months. We expect that the updated document will not differ substantially from the draft version.

Taxpayer input to CASD

Rheault: What is the rationale for removing the requirement that taxpayers provide their views on any possible basis on which to resolve the issues in MAP cases?

Brault: The removal relates to efforts to standardize MAP document requirements under BEPS Action 14 Minimum Standards and the FDA MAP Forum Inclusive Framework. CASD wanted to ensure that this would not become a barrier for MAP requests to be eligible.

Obviously, taxpayers views on potential bases for resolution will continue to be helpful and welcome by the team, but they are no longer required in order for Canada to consider a MAP request.

Presentation to CASD “well before” time limit

Rheault: Not all treaties provide that MAP relief can be applied notwithstanding domestic statutory limitation periods. The draft Circular provides that, when a Treaty does not override the domestic time-limits for relief, a case should be presented to the Competent Authority Services Division “well before” the expiry of time-limits.

Why is that necessary if an objection or waiver is filed, and what does “well before” mean?

Brault: The best practice is to read “well before” as “as soon as possible.” If you know there are some taxation years that will soon become statute barred, keep in mind that even if a MAP request was made on a timely basis, there are some Treaties that do not have rules allow for MAP relief to be provided beyond the domestic time limits. In those cases, CASD will not be able to adjust the tax returns and provide relief if the years in question have become statute-barred prior to the MAP cases being resolved between the competent authorities.

Taxpayers are responsible for taking steps to prevent taxation years from becoming statute-barred under the ITA, e.g. by providing a waiver, and of course, 24 months is the average time required.

CASD’s refusal to negotiate s. 247(2)(d) assessments

Rheault: The draft Circular formalizes the CRA’s policy to generally refrain from negotiating MAP cases if the reassessment is based on s. 247(2)(b) recharacterization. This position has not been tested in court. Can the CRA clarify the legal basis for this position?

Brault: To clarify, when we say CRA will not renegotiate, it is important to remember that CASD will accept a MAP request from a Canadian taxpayer where the reassessment involves recharacterization.

However, s. 247(2)(b) and (d) are part of our domestic anti-avoidance legislation. As with GAAR cases, CASD will not revisit CRA's conclusions under s. 247, but will submit the case to the other competent authority who may decide to provide relief on their end.

Canada does not consider anti-avoidance adjustments to result in taxation that is not in accordance with the Treaty. This is consistent with the OECD guidance on the application of domestic anti-abuse rules and with BEPS Action 14, Minimum Standards.

CASD’s willingness to negotiate Treaty anti-abuse provisions

Rheault: The draft Circular suggests that the CRA will, however, negotiate in cases where the anti-avoidance provision is found in a treaty rather than the Act.

Brault: That is correct. A distinction is being made between domestic and treaty anti-avoidance rules.

In practice, we do not expect this will happen frequently or that we would come to a completely different view but, consistent with the OECD guidance on the application of the rules, CASD would be expected to review MAP requests in the case where the MLI and the PPT would apply.

Downward adjustments

Rheault: Draft IC 71-17 provides that a taxpayer’s request for a downward adjustment will be referred to CASD if it involves a Treaty country. Subsection 247(10) is the provision in the Act where the correct determination of a taxpayer’s income is subject to Ministerial discretion.

What are the criteria for exercising this discretion?

MacLean: What we are really after is a consistent approach. We want to centralize downward requests in ILBD headquarters for the purpose of applying the criteria consistently across the board – and we do not get many of them.

Obviously, it is better for the taxpayer to get it right the first time rather than seek a downward adjustment.

It is worth bearing in mind that, while it is true that the formal call for discretion in s. 247(10) is unusual, in practice it is not very unusual – CRA auditors have to exercise their discretion all the time.

As to the key criteria, the general idea is that there should be a single layer of tax. We want to avoid double-taxation, but we also want to avoid what the OECD has helpfully dubbed “double non-taxation.” We have seen some downward requests in the past that seem to reflect retroactive tax-planning, or that appear to be an effort to have the income included nowhere on the planet, rather than an effort to achieve an arm’s-length price in support of the arm’s length principle.

Transfer pricing review committee (TPRC)

Activity in recharacterization (hybrid debt transactions)

The Slide shows statistics on the TPRC’s recharacterization files. There has been a fairly steady increase over the past two and a half years. The last year shown in this graph is 2020/2021 which still has not completed. for us, but we see a steady increase. We are now up to 58 cases heard by the TPRC in our current fiscal period.

The pink portion is for those cases that have been approved, the green portion, for those that have been denied, and the grey portion, for those that are still ongoing.

The Transfer Pricing Review Committee is consulted at three stages. The first stage is informal initial consideration. The second stage is usually after the audit work is well underway, mostly completed, and we are about to propose recharacterization – it comes to the TPRC for formal approval. The third stage is after recharacterization has been proposed to the taxpayer, at which stage the TPRC will consider the representations from the taxpayer and decide on whether to approve recharacterization.

The steady increase is directly a result of our hybrid debt project on which we usually apply recharacterization.

Penalty cases

Another Slide depicts the penalty cases that have been heard by the Transfer Pricing Review Committee over the past few years. The last year again is 2020/2021, which still is not complete. The total number of cases heard goes from 66 at the end of the 2018 fiscal year, to 49 for 2019, 62 for 2020, and 37 for the current fiscal year. The red portion on the graph represents the penalties that have been recommended by the TPRC – and the grey portion, the ones that are not recommended. Approximately 40 to 50% of penalty cases are recommended and approved by the TPRC over the years.

TPRC and double taxation

The TPRC does not consider double taxation. Our recharacterization provisions are domestic anti-avoidance rules essentially, and so the TPRC really is only concerned with whether those rules actually apply. The risk of double taxation is something taxpayers should consider when they decide to enter into what we would consider aggressive international transactions that may lend themselves to the recharacterization.

COVID-19 and Residence

Rheault: Can the CRA give an update on its COVID-19 guidance?

Jennings: Our administrative approach was outlined on our website, including guidance on corporate residency, permanent establishments, and other similar considerations.

That guidance expired on September 30th, and we have decided not to extend the corporate residency guidance beyond September 30th, mostly because residency determinations need to be addressed on a case-by-case basis, especially if businesses start adopting new ways of doing business after the pandemic crisis is over.

If residency issues arise during a future audit, rest assured that the CRA will give due consideration to the extraordinary circumstances and temporary impacts of the pandemic (travel restrictions, etc.) in its overall evaluation of the facts during such an audit.

Contemporaneous documentation

Rheault: Can CRA comment on the requirements for contemporaneous documentation for transfer-pricing?

Jennings: CRA does not intend on diverting from its current guidance in TPM-9 regarding requirements for preparing contemporaneous documentation. We consider that TPM-9 provides the appropriate guidance on reasonable efforts.

We also participated in the OECD guidance that was released in December 2020, that focused on the impact of COVID 19 and transfer pricing.

CEWS and TPM-17

Rheault: Has CRA considered its position in IFA 2020 Q.5, in light of the OECD’s differing views?

Jennings: No. The CRA will continue to evaluate transfer prices in accordance with its guidance on government subsidies in TPM-17. Our position essentially is that the arm’s length principle would probably not be respected by simply assuming that the receipt of government assistance or subsidies would impact the prices. We consider that a proper comparability analysis needs to be performed during the audit to establish that.

Scope of CEWS audits

Heale: Does the CRA intend to audit all CEWS claims? Has it identified any specific abusive patterns?

MacLean: No, we do not intend to audit every wage subsidy claim. There is quite a number of applications – over 2 million if you look period-by-period – so that 100% coverage is infeasible.

However, we are pretty pleased with the level of coverage we are achieving so far, having started our Phase One audits this summer as well our prepayment validation work.

It is early to be reporting on fact patterns. I would say we are pleased with the level of cooperation we are getting, e.g. on documentation and communication, particularly in the large business space. We are seeing a number of files that are really completely unproblematic.

There are also some files that are under consideration for referral to the Third Party Penalty Committee. There are some promoted schemes and issues of that nature that we are monitoring.

Audience questions

Soft Recharacterization

Billings: How common is it for CRA to assert that a transaction “simply wouldn’t have happened,” and deny a deduction without formally invoking s. 247(2)(d)?

MacLean: That has been alleged often in the past, but CRA is increasingly comfortable with invoking paras. (b) and (d) other than as a last resort.

Paras. (a) and (b) have some overlap, and it’s often not necessary to change the underlying terms and conditions of an arrangement in order to reach an appropriate transfer pricing result.


Billings: Given the outcome of Cameco and Agracity, is CASD open to working with Appeals in some sort of process whereby the s. 247(2)(b) issue could be addressed first, and then the taxpayer is open to seek more traditional relief through a MAP?

Brault: Typically, if there is an objection, and the taxpayer comes to CASD, the objection will be held in abeyance while the file is reviewed.

As for Cameco and Agracity, the Crown is seeking leave to appeal.

CbC Compliance Reviews

Billingst: Can CRA comment on whether data provided in CbC reports are leading to audits or audit-like activities?

Jennings: We are conducting filing compliance audits to ensure that the information provided on these returns is accurate. This is important for us because the CbC reporting is for risk-assessment, and it cannot serve that function if the information therein is inaccurate.

We have noticed growing pains in this area, e.g. income getting reported in two different places, such as dividends.

Distinction between TPRC no-penalty recommendation and insufficient documentation notation

Billings: Sometimes TPRC decisions conclude that no penalty is recommended, and sometimes the conclusion is that the documentation submitted did not allow a conclusion as to whether there were reasonable efforts. Can you comment on the rationale for that distinction?

Jennings: The first “no penalty is recommended” wording is in a memo issued to the field, and is clear-cut.

The other wording, stating that “the documentation provided is not sufficient” for the Committee to make that determination, is typically used in cases where we are considering s. 247(3), which involves factual determinations on whether the taxpayer made reasonable efforts to determine and use arm’s-length prices. These situations are often not as clear-cut as the deeming provisions under s. 247(4). Therefore, that wording is usually used in situations where we were seriously considering whether a s. 247(3) penalty would apply, but considered that the information before the Committee was insufficient. That is not to say that the penalty would not be considered in the future in a similar situation.