Transfer Pricing | Canadian Tax Decisions & Tax Law

Transfer Pricing and Controlled Foreign Subsidiaries

Mazen Artistic Aluminum Ltd. v. The Queen, 2014 TCC 194

At issue were amounts paid by the Canadian resident corporation to its wholly owned subsidiary, located in a low-tax jurisdiction, for services provided to the Canadian resident corporation. Specifically, whether the terms and conditions as between the related parties were ones that differ from what would have been agreed to by parties at arm’s-length.

FACTS

The Canadian resident corporation, on advice from professionals, set up a structure whereby it incorporated a wholly owned subsidiary in a low-tax jurisdiction, paid amounts to this subsidiary in pursuit of active business profits internationally (Marketing, promotions, management, and administrative), and paid these amounts back to itself tax free (deducting dividend under s 113).

The MNR reassessed these payments as not meeting proper transfer-pricing guidelines as a violation of the arm’s-length principle, under s 247(2).

ANALYSIS

The Court noted that the foreign company could do nothing on its own – it was an empty shell devoid of personnel and tangible or intangible property/assets. It reviewed the potential service provided and value added by the foreign corporation and found there to be little evidence of anything.

The court the summarized the arm’s length principle:

[170] The arm’s length principle assumes that independent enterprises “… will compare the transaction to other options realistically available to them, and they will only enter into the transaction if they see no alternative that is clearly more attractive”.

The Court concluded, on the evidence, that there was no benefit other than a tax benefit to be found in the arrangement (para 172), neither of which would be available for arm’s-length parties.

The Court then considered the appropriateness of the quantum of fees paid. The ITA does not provide much guidance in subsection 247(2) as to how to determine the arm’s length price, and courts have held that recourse to the OECD Guidelines is appropriate: Canada v. GlaxoSmithKline, 2012 SCC 52; The Queen v. General Electric Capital of Canada, 2010 FCA 344; and Alberta Printed Circuits Ltd. v. The Queen, 2011 TCC 232 , as is reference to the CRA’s IC 87-R2.

Transfer pricing analysis is highly fact-driven. The first step is identifying the transaction under review. Once this is done, the next step is determining the appropriate method to use so as to arrive at an arm’s length transfer price appropriate for the facts. The Court noted that although the 2010 OECD Guidelines don’t provide a preference of methods, the 1995 OECD Guidelines listed the various methods in decreasing order of reliability, being:

1. Traditional Transaction Methods:

Comparable Uncontrolled Price method (“CUP Method”) Respondent [108] and [160] – value of Mr. Csumrik and Longview
Resale Price method
Cost Plus method

2. Transactional Profit Methods:

Profit Split method
Transactional Net Margin method (“TNMM”)

The Court preferred the CRA’s expert method using CUP over the Appellants method using TNMM, on the facts. Specifically, the court used the internal CUP being the price negotiated between the third party advisor and the Canadian Parent as the appropriate comparator.

Sas Ansari, BSc BEd PC JD LLM PhD (exp) CPA In-Depth Tax 1, 2 &3

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Denial of Voluntary Disclosure Application – Motion to Strike Judicial Review

Canada (National Revenue) v Sifto Canada Corp, 2014 FCA 140

The FCA dismissed an appeal of the FCTD’s dismissal of the Crown’s motion to strike two applications of judicial review (2013 FC 214) on the basis that there was sufficient doubt about the Minister’s position that one of the JR applications should not be allowed to continue (despite the multiplicity of proceedings (para 26).

The FCA held that a challenge to the discretionary exercise of power (in this case discretion to waive penalties and interest) can only be made by way of judicial review to the Federal Court. (para 23). Potential remedies are a declaration based on administrative law principles that the Minister acted unreasonably in failing to waive the penalties, a declaration that the penalties should not have been assessed in the face of a valid voluntary disclosure, or an order precluding the Minister from enforcing the penalty assessment or collecting the resulting tax debt (para 25).

FACTS

Sifto submitted an application under the Voluntary Disclosure (“VD”) program in relation to the transfer price of Rock salt it sold to a related US corporation. The Minister accepted the disclosure as meeting the requirements of the program, entered into agreements with Sifto to settle its income tax liability (on the basis of the mutual agreement price as between the US and Canada), BUT then issued assessments and reassessments using a price other than the mutual agreement price AND included penalties under subsection 247(3) of the ITA.

Sifto took the position that once the Minister accepts the VD as meeting the conditions of the program, the Minister is bound to waive penalties and interest, consistent with the published terms and conditions of the VD program.

ANALYSIS

The VD program induces taxpayers to disclose past compliance errors in the expectation that, if the disclosure is accepted as meeting the program conditions, any penalties and interest that may have been imposed in relation to the disclosed errors would be waived (under the Minister’s authority in subsection 220(3.1))

The FCA referred to the CRA’s published policy (IC 00-1R2 – Current version IC00-1R4) that contains the 4 conditions for a valid disclosure (voluntary, complete disclosure that involves application or potential application of a penalty, and information that is at least one year old). The FCA notes that the record before it did not contain an explanation for the Minister’s decision.

The Court reviewed the law as to preliminary motions to strike, noting that such a motion fails ” unless the application is so clearly improper as to be bereft of any possibility of success: JP Morgan, 2013 FCA 250 at paragraph 47; David Bull Laboratories (Canada) Inc. v. Pharmacia Inc., [1995] 1 F.C. 588 at page 600 (C.A.)).

The standard of review was set out in Apotex Inc. v. Canada (Governor in Council), 2007 FCA 374 at paragraph 15 (cited with approval in Canada v. Domtar Inc., 2009 FCA 218; Canadian Imperial Bank of Commerce v. Canada, 2013 FCA 122) :

The respondents correctly point out that the decision to grant or refuse a motion to strike is a discretionary one. When the lower court judge has made a discretionary decision, it will usually be afforded deference by the appellate court. However, the latter will be entitled to substitute the lower court judge’s discretion for its own if the appellate court clearly determines that the lower court judge has given insufficient weight to relevant factors or proceeded on a wrong principle of law: Elders Grain Co. v. Ralph Misener (The), 2005 FCA 139, at paragraph 13. This Court may also overturn a discretionary decision of a lower court where it is satisfied that the judge has seriously misapprehended the facts, or where an obvious injustice would otherwise result: Mayne Pharma (Canada) Inc. v. Aventis Pharma Inc., 2005 FCA 50 at paragraph 9.

Sifto’s argument was that the Minister has to honour the promise implicit in the VD program as described in the Information Circular. The FCA held that the record discloses no reason for it to interfere. The Federal Court has jurisdiction over some aspects of Income Tax assessments. It is only the Tax Court that has the jurisdiction to determine whether all of the statutory conditions for the imposition of the penalty were met (para 22), but the Tax Court does NOT have jurisdiction to determine whether the Minister properly exercised its discretion under subsection 220(3.1) – a challenge to the discretionary exercise of power can only be made by way of judicial review to the FC (para 23).

As for remedies, the FCA held that the FC could grant a declaration based on administrative law principles that the Minister acted unreasonably in failing to waive the penalties, a declaration that the penalties should not have been assessed in the face of a valid voluntary disclosure, or an order precluding the Minister from enforcing the penalty assessment or collecting the resulting tax debt (para 25).

– Sas Ansari, JD LLM PhD (exp)

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Income Tax – HST/GST – International Tax