Words and Phrases - "reasonable efforts"


Brian Mustard, Sam Maruca, Charles Thériault, Richard Tremblay, "Transfer Pricing: What Are 'Reasonable Efforts,' and When should Penalties Apply?", Canadian Tax Foundation, 2015 Conference Report, 32:1-33

Unlikelihood of a s. 247(4)(a) safe harbour (p. 32:7)

[T]he qualitative assessment of the adequacy of the actions described in subsection 247(4) lies entirely within the ambit of subsection 247(3). In other words, subsection 247(4) seems to require only a recitation of the facts that demonstrate the effort made; subsection 247(3) is where the efforts are analyzed to determine whether they were reasonable. The fact that paragraph 247(4)(a) only requires taxpayers to document what work they in fact did to determine the arm's-length transfer price or allocation—regardless whether such work represents reasonable efforts—will likely make courts reluctant to view paragraph 247(4)(a) as establishing a safe harbour.

Dichotomy between arm’s length prices and arm’s length allocation (pp. 32:7-8)

"[R]easonable efforts" in subsection 247(3) refers to the determination and use of arm's-length transfer prices or arm's-length allocations, and not to arm's-length terms and conditions, which are the subject of the main transfer-pricing provision in subsection 247(2). The term "arm's length allocation" is defined in subsection 247(1) to mean "an allocation of profit or loss that would have occurred between the participants in the transaction if they had been dealing at arm's length with each other [emphasis added]." However, the "allocation" wording is not found in subsection 247(2); it is only used in subsections 247(3) and (4). ...

Regardless whether profit allocations can be used under subsection 247(2) in circumstances where they do not permit the determination of specific terms and conditions in respect of a transaction, it is clear that they can be used as a defence against the application of transfer-pricing penalties. So if it makes sense for economic or other reasons to prepare a profit-split analysis rather than a more granular pricing analysis, and assuming that the profit allocation can be defended as flowing from the making of reasonable efforts, penalties should not be applied.

Historical reason for penalty (p. 32:8)

The historical reason for Canada's transfer-pricing penalty is clear. The United States introduced a transfer-pricing penalty before Canada did, and it was not trivial. As a result, when taxpayers were involved in cross-border trade involving Canada and the United States, they would favour recognizing more income in the United States and less in Canada, all things being equal. It was therefore necessary for Canada to level the playing field...

HSBC: Relevance of past CRA audit practices to penalty (p. 32:10)

In HSBC Bank [2007 TCC 307], the taxpayer alleged in its notice of appeal that it had used a transfer price for a decade, and despite annual audits, the CRA never challenged it until the reassessment that led to the appeal….Bowman CJ refused to strike the paragraph because, although previous years are not relevant to the issue of whether there should be a transfer pricing adjustment in a subsequent taxation year, it was not clear and obvious to him that events in previous years would not be relevant to determining whether there should be a transfer-pricing penalty in a subsequent year….

[I]n cases where a subsection 247(4) request for documentation was made, and the CRA expressed no concern with the documentation, it is entirely reasonable in those circumstances for a taxpayer to believe that it had met the acceptable standard and to continue producing similar contemporaneous documentation for subsequent years….To permit the penalty to be applied in such a case would be inappropriate and contrary to the principles of certainty, predictability, and fairness…

Reluxicorp: reasonable efforts if no carelessness (p. 32:11)

[In] Reluxicorp…Lamarre J noted that "there will be carelessness if the person failed to make reasonable efforts to comply with the Act….A technical reading of the statement also suggests that failure to make reasonable efforts is a more grievous offence than carelessness, since the existence of the former necessarily implies the existence of the latter. As a result, if a taxpayer can show that he or she was not careless, the reasonable efforts requirement should be satisfied.

Jurisprudence on “reasonable efforts” (pp. 32:12)

[I]n Barrett, the Federal Court of Appeal determined that "reasonable efforts" is a higher standard than "good faith." …

In Royal Oak Mines [[1996] 1 S.C.R. 369], the Supreme Court of Canada concluded that "reasonable effort" is an objective standard that can be assessed by reference to "comparable standards and practices within the particular industry." …

Rossiter v. Chiasson, [1950] OWN 265 (HCJ)…[stated] the party need not "go to absurd, whimsical or unwarranted lengths" since "reasonable" means " 'logical,' 'sensible' and 'fair.' " …

Crown Employees [1997 CarswellOnt 6197] explicitly held that

reasonable efforts does not mean "all efforts." It does not mean "efforts to the point of undue hardship." It does not mean "every effort." What it means is efforts that are reasonable in the circumstances all things considered. What is reasonable in the circumstances will, obviously, depend on the facts of particular cases.

Informing s. 247 penalty with OECD Guidelines (pp. 32:12-13]

[T]he fact that the CRA and the Department of Finance have both indicated that the section 247 provisions were meant to import the principles of the OECD guidelines into the Act may in some cases provide taxpayers with a basis for interpreting section 247 provisions in a manner that is less demanding than the CRA's publications would otherwise suggest. …

For example, chapter IV of the 2010 OECD guidelines provides…

[I]mposition of a sizable "no-fault" penalty based on the mere existence of an understatement of a certain amount would be unduly harsh when it is attributable to good faith error rather than negligence or an actual intent to avoid tax. …

The CRA addresses some of these points in TPM-09 but indicates, for example, that a penalty would "not likely" be imposed for failure to use data that were not available to the taxpayer. I would argue that the guidelines do not require taxpayers to spend large sums to gain access to private databases that are not otherwise available to them.

This example, along with the CRA's use of the expression "all reasonable efforts" [rather than “reasonable efforts”] and other differences noted above, demonstrates how the CRA guidance perhaps inadvertently imposes a higher threshold for the avoidance of a transfer-pricing penalty than Parliament intended….

Questionable TPM-09 Guidelines (p. 32:14)

The TPM states that the TPRC may take into consideration whether the taxpayer provided all of the items requested under section 231.6 or 231.2…

It is difficult to understand how the compliance or non-compliance of a taxpayer with requirements issued long after transfer-pricing documents were prepared could possibly have any relevance to the reasonable efforts inquiry under subsection 247(3). …

[F]rom informal discussions with CRA personnel, it appears that the TPRC will consider a large adjustment to constitute almost presumptive evidence of non-compliance with subsection 247(3)….

Inappropriateness of penalties where s. 247(2)(d) recharacterization (p. 32:16)

[I] do not believe that transfer-pricing penalties should be imposed merely because recharacterization has been invoked. More importantly, I think it is contrary to the Act for the CRA to conclude otherwise. As I read the words of subsections 247(3) and (4), a penalty can arise only in respect of failure to document the transactions that were actually carried out by taxpayers. The CRA itself admits that paragraphs 247(2)(b) and (d) do not in fact recharacterize the transactions in question. Paragraph 247(2)(d) merely permits the determination of "amounts" based on a different hypothetical transaction, without deeming that transaction to have taken place or to have replaced the actual one. In contrast, the penalty provisions in subsections 247(3) and (4) are entirely based on the transactions actually undertaken by taxpayers. Assuming that the taxpayer has made reasonable efforts to determine and use an arm’s length price or allocation in respect of those actual transactions, subsection 247(3) should not apply.

Appropriateness of avoiding penalties where reliance on expert reports (p. 32:18)

[In DHL Corporation and Subsidiaries v CIR, 285 F. 3d 1210 (9th Cir. 2002); aff'g, in part, rev'g, in part, and remanding 76 TCM 1122 (1998)] the taxpayer ("DHL") hired Bain & Co., Inc. ("Bain") a well known global management consulting firm, to conduct a valuation. The US Tax Court held that it was not reasonable for DHL to rely on that valuation because DHL worked with Bain to arrive at its desired value, and the court imposed a penalty on the taxpayer as a result. The Court of Appeals, Ninth Circuit, reversed the penalty, stating that Bain was a "respected financial firm" and that "[t]here is no evidence that DHL manipulated Bain's appraisal or that Bain blindly affirmed DHL's desired figure.

Words and Phrases
reasonable efforts

Michael Colborne, Michael McLaren, Mark Barbour, "Subsection 247(3): What are "Reasonable Efforts"?", Canadian Tax Journal, (2016) 64:1, 229-43

Dictionary meaning of “reasonable efforts” (p. 236)

On the basis of these definitions, we believe that the ordinary meaning of "reasonable efforts" is "sensible, moderate, yet determined attempts."…

Context of s. 247(3) (pp. 236-7)

As a contextual matter, subsection 247(3) was enacted as part of the 1995-1997 technical bill that added section 247 to the Act—which, as we have noted, was intended to harmonize Canada's, transfer-pricing rules with the arm's-length standard described in the 1995 OECD guidelines….

Subsection 247(3) and all related rules in section 246, including subsection 247(2), should also be viewed in the context of a taxpayer's liability under section 151 to "estimate the amount of tax payable" when the taxpayer files its tax return….[T]his statutory context suggests that in interpreting "reasonable efforts," one should emphasize the "sensible" and "moderate" aspects of the ordinary meaning of "reasonable."

1997 budget and 1995 OECD guidelines referenced therein (pp. 238-9)

The [1997] budget plan indicates that the 1995 OECD guidelines provided the inspiration for the changes to the transfer-pricing rules, including the penalty provisions….

[C]hapter 5 [of the OECD Guidelines] provides that

[t]axpayers should make reasonable efforts at the time transfer pricing is established to determine whether the transfer pricing is appropriate for tax purposes in accordance with the arm's length principle. . . . [The] extensiveness of this process should be determined in accordance with the same prudent business management principles that would govern the process of evaluating a business of a similar level of complexity and importance. [fn 31: … 1995 OECD guidelines, at paragraph 5.28 (emphasis added). …

the need for the documents should be balanced by the costs and administrative burdens, particularly where this process suggests the creation of documents that would not otherwise be prepared or referred to in the absence of tax considerations.

CRA position on reasonable efforts (p. 241)

[T]PM-09 also states:

A reasonable effort means the degree of effort that an independent and competent person engaged in the same line of business or endeavour would exercise under similar circumstances. What is reasonable is based on what a reasonable business person in the taxpayer's circumstances would do, having regard to the complexity and importance of the transfer pricing issues that arise in the taxpayer's case. …

[R]egardless, we have seen the CRA assert penalties in circumstances where it ought to be uncontroversial that reasonable efforts were made.

Conclusion (p. 243)

Application of the textual, contextual, and purposive approach to statutory interpretation mandated by the Supreme Court of Canada supports the conclusion that Parliament intended the phrase "reasonable efforts" in subsection 247(3) to require a determination of whether a taxpayer attempted to establish an arm-length price as a prudent business person would do in the same circumstances….

Words and Phrases
reasonable efforts