News of Note
CRA summarizes how to delineate a transaction for transfer-pricing purposes
Email this ContentAs part of his responses to questions posed at the 27 February 2024 CTF Transfer Pricing Roundtable, Frédéric Bourgeois set out a conceptual framework used in analyzing transfer-pricing issues. Here is a summary:
“Delineation” of a transaction
Consistent with the transfer-pricing guidelines (TPG), the delineation process requires outlining what has actually occurred between the parties, not simply a description of the legal agreement.
While the inter-company agreement can be a good starting point, what is needed is a detailed outline of what the parties actually did in terms of functions, assets consumed, and risk assumed; what they did for one-another, did separately, and how all this resulted in the creation of value in the business.
Commercial rationality of a transaction
Commercial rationality is another process that is linked to the transfer pricing analysis. It can really be understood as an economic test. It asks whether arm’s length parties acting in a self-interested, commercially rational manner, would have entered into the transactions with stated terms and conditions under the economic circumstances that they are each operating under. Each party would take into account the options realistically available for their business in their decision-making as to whether to enter into a transaction and what should be the terms and conditions of the transaction.
Therefore, commercial rationality requires consideration of the reasonable expectations of the best possible outcome for the entity. For the purpose of documenting commercial rationality of a transaction, taxpayers should provide an economic discussion to explain the nature of the transaction and should include consideration of the history of the arrangement and the activity of the broader market to justify the tested party’s decision.
Ultimately, the purpose of the inquiry is to determine whether the arrangement would have been agreed to by unrelated parties. As stated in the TPGs, the key question in the analysis is whether the related party arrangement exhibits the commercially rational terms and conditions that would be agreed between unrelated parties under comparable economic circumstances.
Who bears the risk?
Lastly, on the concept of who bears the risk, CRA would not, at first, differentiate between inbound (Canadian subsidiary) and outbound (Canadian parent) transactions. The transaction is analyzed in its totality. Generally, duly staffed and funded incorporated businesses are responsible for the risks that are inherent in their business and have the financial capacity to bear the risk. Any interaction with a related party carries compensation for the services that are provided, commensurate with the risk of providing the service as determined by a comparability analysis.
Generally, CRA sees risk as linked to the functions and assets. That is, the risk follows the functions and the assets, and the taxpayer’s efforts to decouple risk from functions and assets, as if risk were some form of commodity to be traded, is troublesome and not in CRA’s view how the TPGs should be interpreted and applied.
Neal Armstrong. Summaries of 27 February 2024 CTF Transfer Pricing Roundtable under s. 231.1(1), s. 247(2), s. 247(3) and s. 271(4).
Brookfield Renewable Power – Quebec Court of Appeal confirms the reduction of the deductible interest on loss consolidation loans from 14% to 8.75% based on parent’s borrowing costs
Loss consolidation transactions between a “Lossco” in the Brookfield group (“BRPI”) and “Profitcos” resulted, for instance, in BRPI holding $2.3 billion of loans in its Profitco subsidiary, and the Profitco holding $2.3 billion of preferred shares of its parent until this reciprocal arrangement was reversed five months’ later. The ARQ assessed to deny the deduction of the interest in excess of 6%.
The Court of Quebec reviewed inter alia the Gervais Auto decision, and also referred to the evidence of the two ARQ experts indicating that BRPI had been borrowing from arm’s length lenders at around that time at rates ranging between 6.00% and 8.75%; and to a written concession of the ARQ counsel that an interest rate as high as 8.75% could be justified as reasonable. It then referred the appeal back to the ARQ for reassessment on the basis of allowing the interest deduction at an 8.75% rate.
In finding that no reversible error had been made, the Court of Appeal stated:
In short, in accepting the expert reports produced by the respondent, the judge did not limit himself to applying an arm’s length test to the detriment of that of reasonableness. Instead, he favoured an approach based on the correct criterion, taking into account the particular nature of the transactions carried out … in the context of the consolidation of losses … and retaining, as an objective element … the financing costs incurred by the parent company and BRPI at the relevant time. This approach, which does not depart from the teachings of Gervais Auto, is not tainted by any error of law.
Neal Armstrong. Summary of Brookfield Renewable Power Inc. (Corporation Énergie éolienne Brookfield inc.) v. Agence du revenu du Québec, 2025 QCCA 234 under s. 20(1)(c)(i).
CRA indicates that the processing of fuel could constitute “processing” for ITC and Class 29 purposes
Whether equipment acquired by the taxpayer qualified for the Atlantic investment tax credit (AITC) turned, in part, on whether its use in the production or processing of fuel could be considered to be the manufacturing or processing of goods for sale in the context of the description of a Class 29 property (and as required by the definition of “qualified property” in s. 127(9).) After referring to the meaning accorded to “processing” in Tenneco and Repsol, CRA stated that “in our view the production or processing of a fuel could be considered to be the manufacturing or processing of a good for sale for purposes of the AITC depending on the particular circumstances.”
Neal Armstrong. Summary of 23 April 2024 External T.I. 2024-1004511E5 under s. 127(9) – qualified property - (c)(i).
Income Tax Severed Letters 5 March 2025
This morning's release of three severed letters from the Income Tax Rulings Directorate is now available for your viewing.
RTI – Court of Quebec confirms that it had no jurisdiction to deal with over-remittances of source deductions
Couture JCQ confirmed that the Court of Quebec had no jurisdiction to consider a Notice of Objection of the taxpayer based on the failure of the ARQ to refund source deductions which it alleged that it had over-remitted, given that the Quebec equivalent of ITA s. 171(1) only accorded the Court of Quebec jurisdiction to deal with assessments. Here, there was no assessment that had been objected to.
Neal Armstrong. Summary of RTI Turbo Inc. v. Agence du revenu du Québec, 2025 QCCQ 231 under s. 171(1).
A convertible debenture held by a non-resident could trigger the FAD rules
Suppose that a widely-held private corporation resident in Canada (the “CRIC”) will emigrate from Canada for non-tax reasons. However, a non-resident corporation (“Forco”) that is not a current shareholder had acquired, prior to the emigration, a convertible debenture which, when converted after the emigration, results in Forco having de jure control of the CRIC.
Under s. 212.3(1)(b), the s. 212.3 rules apply to an investment made by the CRIC in a subject corporation if as part of the series of transactions that includes the making of the investment, Forco acquired control of the CRIC and at the time of the “investment”, the Forco shares represented 25% or more of the votes or value of the CRIC – with s. 251(5)(b) rights being taken into account for these purposes. Accordingly, on the conversion of the debentures after the emigration, Forco could be the parent of the CRIC for purposes of the s. 212.3 rules in respect of any investment made during the period in which it held the debentures before the emigration, if the debenture conversion occurred as part of the same series of transactions as that investment.
However, the finding in Eyeball Networks - that the concept of a “series of transactions” applies only when one or more of the transactions within the series is primarily tax driven - could be helpful in this regard.
Neal Armstrong. Summary of Mark Jadd and Daniel Safi, “When a Non-Resident Might Qualify as a “Parent” Under the FAD Rules: A Potential for Retroactive Application?”, International Tax Highlights, Vol. 4, No. 1, February 2025, p. 4 under s. 212.3(1)(b).
We have translated 6 more CRA interpretations
We have translated a further 6 CRA interpretations released in December of 2000. Their descriptors and links appear below.
These are additions to our set of 3,123 full-text translations of French-language Technical Interpretation and Roundtable items (plus some ruling letters) of the Income Tax Rulings Directorate, which covers all of the last 24 ¼ years of releases of such items by the Directorate. These translations are subject to our paywall (applicable after the 5th of each month).
CRA rules on a cross-border butterfly
CRA has ruled on a relatively straightforward cross-border butterfly. Before the distribution of the shares of Foreign Spinco (holding the business to be spun-off) by its parent (Foreign Services) up the chain for distribution by Foreign Pubco to its shareholders, it was necessary for the Canadian spin business carried on through a Canadian subsidiary (Subco 1) of a Canadian subsidiary (DC) of Foreign Services to be transferred in a butterfly spin-off to a new Canadian subsidiary (TC) of Foreign Spinco.
As with other cross-border butterflies, it was required, in order to avoid Foreign Spinco becoming a deemed transferee corporation at any time in the series as a result of becoming a shareholder of DC, to accomplish the transfer of DC preferred shares to TC pursuant to a three-corner agreement among Foreign Services, Foreign Spinco and TC, i.e.:
1) Foreign Services transfers the DC preferred shares directly to TC as consideration for the shares of Foreign Spinco issued in step 3;
2) TC issues common shares to Foreign Spinco as consideration for those DC shares; and
3) As consideration for the TC shares, Foreign Spinco issues shares to Foreign Services.
DC then spins off the relevant business assets (the Subco 1 shares) to TC, and the two cross pref shareholdings are redeemed for notes, which are set-off.
Also, as in other cross-border butterflies, the shares of Foreign Spinco were effectively required by s. 55(3.1)(b)(i)(A)(II) to at no time in the series derive 10% or more of their FMV from the Canadian spin business (or the shares of TC). In this regard, CRA ruled that, for the purposes of s. 55(3.1)(b)(i)(A)(II), in determining whether 10% or more of the FMV of the Foreign Spinco common shares is derived from shares of TC or DC “any indebtedness of Foreign Spinco that is not a secured debt and that is not a debt related to a particular property will be considered to reduce the FMV of each property of Foreign Spinco pro rata in proportion to the relative FMV of all property of Foreign Spinco.”
Neal Armstrong. Summary of 2023 Ruling 2022-0943871R3 under s. 55(3.1)(b)(i)(A)(II).
Lithium Americas continued to Switzerland from B.C. and Almonty, a CBCA corp is proposing to be domesticated in Delaware
Lithium Americas continued from B.C. to Zug, Switzerland on or about January 23, 2025 and Almonty Industries is proposing to use the CBCA continuation procedures and the domestication procedures under the Delaware General Corporation Law Inc. (the “DGCL”) so as to become governed by the DGCL. Management anticipated that the Lithium Americas continuation did not result in any exit tax under s. 128.1(4)(b) or 219.1 and, similarly, the domestication of Lithium Americas is not anticipated to result in material exit taxes.
Neal Armstrong. Summary of 23 December 2024 Management Proxy Circular of Lithium Americas under Public Transactions – Other – Continuances/ Migrations and summary of 6 February 2025 Management Proxy Circular of Almonty Industries Inc. under Other – Continuances/Migrations.
CRA notes that it generally will be impossible for a resident individual to properly compute the Canadian income tax results of holding to maturity a UK endowment policy
An individual, while a non-resident, acquired in 1998 a United Kingdom mortgage endowment policy as an investment plan with a life insurance component. The policy matured in 2023 and the individual received a lump-sum amount from the policy issuer, while a resident of Canada.
CRA noted:
- It had “previously opined that a UK endowment policy would appear to be a life insurance policy within the meaning in subsection 138(12)“.
- On the immigration, the ss. 128.1(1)(b) and (c) rules would apply.
- Although a life insurance policy issued by a non-resident insurer is not specifically precluded from qualifying as an exempt policy, this would require actuarial calculations and information that only the issuing insurer will possess.
- Similarly, the determination of the amounts to be used to compute any policy gain with respect to a life insurance policy (e.g., proceeds of disposition and adjusted cost basis) generally requires information that would be available only in the accounts of the issuer of the policy (i.e., the insurer).
Neal Armstrong. Summaries of 27 January 2025 External T.I. 2024-1018491E5 under s. 138(12) – life insurance policy and s. 148(9) – ACB.