CRA intent to apply the 2017 Transfer Pricing Guidelines to pre-2017 taxation years (pp. 10-11)
The CRA indicated [in 2018 CTF Rouundtable, Q.4] that it will apply the 2017 Transfer Pricing Guidelines [OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations 2017 (July 10, 2017)] to pre-2017 taxation years, as well as to the interpretation of treaties entered into post-2017. However, the CRA does not consider such an application to be retroactive, due to its characterization of the 2017 Transfer Pricing Guidelines as merely an elaboration on the prior guidance. …
As noted…in Prévost Car…later guidance from the OECD can be helpful to the interpretation and application of existing bilateral tax treaties, when it "represent[s] a fair Interpretation" of the OECD Model Tax Convention (the "Model Treaty") and does not conflict with the guidance that was in place at the time a specific treaty was entered into.
New OECD “value creation” concept focuses on economic substance rather than legal relations (pp. 11- 12)
[T]he 2017 Transfer Pricing Guidelines… reoriented transfer pricing as revolving around the concept of value creation… .That criterion is intended to ensure that profits are taxed where economic activities take place and value is created… .
…The OECD's attempt to deemphasize contractual allocations of functions, assets and risks represents a significant change in approach to transfer pricing — particularly if it were to be applied in countries such as Canada, that generally respect the legal form of transactions (rather than allowing a recharacterization in accordance with underlying economic substance). Recently, the Crown's approach in Cameco … was, in essence, congruent with the “value creation” concept… .
New OECD “accurate delineation” concept entails transaction recharacterization (p. 12)
The 2017 Transfer Pricing Guidelines also introduce the concept of "accurate delineation", which essentially proposes that in order to compare a transaction between associated enterprises with a comparable transaction entered into between independent parties, it is necessary to first "accurately delineate" the former transaction in light of "economically significant characteristics". However, such economically significant characteristics…include 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….
OECD recharacterization approach includes treating debt as equity (p. 13)
[I]n the OECD’s recent [Discussion Draft on Financial Transactions released July 3, 2018] … an example is … given of a purported loan being accurately delineated as equity, chiefly because of a low likelihood of repayment within the specified term. However, under Canadian law, the nature of an instrument as debt or equity is determined by general legal principles, pursuant to which the form or label attached to an instrument can be overturned only if the legal substance of the arrangement is clearly different, not because the economics are such, that an arm's length party might have chosen to subscribe for shares rather than make a loan.
Departure of new guidelines from s. 247 (p. 14)
Not only do these new concepts in the 2017 Transfer Pricing Guidelines depart from the 1995 Transfer Pricing Guidelines, they also have little grounding in section 247 of the ITA or Canadian transfer pricing case law. …
Further, the 2017 Transfer Pricing Guidelines' "accurate delineation" concept could cause recharacterization in a domestic Canadian transfer pricing dispute under paragraphs 247(2)(a) and (c) of the ITA in circumstances where not even the explicit mandate in the ITA's transfer pricing recharacterization rule … would do so. Pursuant to paragraphs 247(2)(b) and (d) of the ITA, the [rule] only permits recharacterization of controlled transactions if arm's length parties-would not have entered into such transactions and a tax avoidance motive test is satisfied….
[A]lthough the OECD’s guidelines may be relevant for interpretative purposes, they do not override domestic Canadian law….
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. (p. 12)
As an example of this recharacterization 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 Roundtable, 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.
Email this Content