Recent developments in Canadian transfer pricing

Tax Executive, The, May-June, 2003 by Nathan Boidman

* When a Canadian parent company requests a decrease in the transfer price of sales to a non-arm's length non-resident without repatriation and subsection 15(1), 56(2), or 246(2) does not apply to the amount. This situation may be considered abusive because the Canadian taxpayer has turned an otherwise taxable receipt of monies into a nontaxable amount.

Significantly, it is an untested question whether a Canadian court would consider such an exercise of discretion to conform to the foregoing principles respecting the exercise by government of any discretion provided it by a statute.

The communique then goes on to specify that, where relevant, adjustments are to be directed to either (or sometimes both) the Director General of the International Tax Directorate (in Ottawa) or the head of a (district) Taxation Service Office. (29) The communique correlates the instruction to six examples (30) and, among other things, distinguishes between adjustments that exceed $500,000 and those that do not.

In light of the role that repatriation or lack of repatriation might play in determining what situations are abusive, the communique both notes the role of Part XIII withholding tax with respect to outbound repatriation payments (e.g., outbound payment of a royalty would attract a 25-percent withholding tax subject to treaty reduction) and the procedures that CCRA acknowledges to constitute repatriation payments. (31)

Finally, the communique notes the relationship between the issues of downward adjustments and repatriation payments under treaty competent authority or exchange of information procedures.

(1) Note, however, recent European Community initiatives in this area, as well as those of U.S. Senator Bryon Dorgan.

(2) Section 247(2) of the Income Tax Act (Canada) R.S.C. 1985, Chap. 1 (5th Supp.) (hereinafter "the Act") adopts the principle by requiring intercompany prices that conform to "those that would have been made between persons dealing at arm's length...."

(3) At this juncture, there is no compelling evidence that this difference between the two countries (i.e., the absence of any detailed rules in Canada) affects the manner in which any particular transfer price issue would be decided by courts in the two countries. In this respect, see the departure from the regulations by the court in E.I. duPont de Nemours & Co. v. United States, 608 F.2d 445 (Ct. Cl. 1979), cert. denied, 445 U.S. 962 (1980), aff'g 7801 USTC [paragraph] 9633 (Ct. Cl. Trial J. 1978).

(4) OECD Committee on Fiscal Affairs, "Transfer Pricing and Multinational Enterprises" (1979). For the revised guidelines, released from July 1995 through February 1998, see Organisation for Economic Cooperation and Development, "Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations."

(5) Information Circular 87-2R, "International Transfer Pricing" (Sept. 27, 1999).

(6) Somewhat ironic (having regard to the fact that the imposition of transfer pricing-related penalties requires a showing by the tax administrators that taxpayers' prices do not conform with the arm's-length principle) is that, except for one case in Canada, neither Canada nor the United States has seen a court decision respecting transfer pricing issues between units of a multinational both operating in high tax jurisdictions. In that 1962 Canadian case, the government lost. See J. Hofert Ltd. v. M.N.R., 62 DTC 50 (T.A.B.) (1962). In Hofert, the court stressed that transfer pricing is nothing but a question of the facts and circumstances where, everything else being equal, the most compelling evidence would be a comparable uncontrolled price (not found in that case) even though that notion had yet to see the light of day in legal orthodoxy. (The decision predated by 6 years the 1968 issuance of the first set of regulations under U.S. section 482 and 17 years before the first OECD Guidelines.) See also "Final Section 482 Rules Likely This Year, Will Not Require the Use of CPI Test, Mogel Says," BNA Daily Tax Report (No. 184), at G-1 (Sept. 22, 1992) (quoting U.S. International Tax Counsel James Mogel that the right answer is a "great deal more flexibility and broad principles from which you can then go to a facts and circumstances analysis").