Transfer Pricing Monitor: July 22, 2014

Four Notable 2014 Canadian Transfer Pricing Developments: 


1. Revised Canadian Revenue Agency (“CRA”) Transfer Pricing Memorandum 05 – Requests for Contemporaneous Documentation: 

Key Points raised in the revised Transfer Pricing Memorandum include:

  • Greater emphasis on the fact that auditors must issue, without discretion, a request for the contemporaneous documentation on initial contact with the taxpayer where there are intercompany transactions.
  • No request for contemporaneous documentation will be issued when an APA covers the intercompany transactions.
  • Examples on the determination of the three month deadline.
  • A statement that the reasonable efforts test will be met if there is compliance with the Pacific Association of Tax Administrators (“PATA”) documentation requirements. 

The inclusion of the PATA standard is an unfortunate addition to the memorandum. The recent draft white paper on transfer pricing documentation from the Organisation of Economic Development and Cooperation (“OECD”) listed a number of shortcomings of the PATA list, not the least being the lack of relevance and burdensome cost of fulfilling the PATA requirements. In addition, with the expectation of the revised chapter on documentation in the OECD transfer pricing guidelines expected this September, the timing of this memorandum’s release appears premature.


2. Release of the CRA Annual Mutual Agreement Procedure (“MAP”) Program Report: 

Key Points from the MAP report include: 

  • Closing inventory of 257 negotiable cases. (An increase from 235 last year) Note: Negotiable cases require bilateral negotiations with another tax administration to resolve double taxation or taxation not in accordance with an income tax convention.
  • Acceptance of 127 new negotiable files to the program (No change from  127 last year)
  • Completion of 105 cases (a decrease from 114 last year).
  • Completion of 88% of the negotiable cases initiated by Canada(92% last year)
  •  An average time of 22.6 months to complete the Canadian-initiated cases. (A decrease from the 26.1 months average time last year)
  • An average time of 30.9 months  to complete the foreign-initiated cases (An increase from the 21.9 months average time last year) 

The annual report still does not report any arbitration statistics.


3. Transfer Pricing Jurisprudence Update: Marzen Artistic Aluminum Ltd.,(“Marzen”): 

Summary of the Facts:

  • Marzen paid a marketing fee to a related Barbados Company, Starline International Inc. (“SII”), who then outsourced Marzen’s related US Company Starline Windows Inc., (“SWI”) to provide such service.
  • The Tax Court of Canada ruled that the majority of the fees paid to SII that were in excess of the fees SII paid SWI would not have been paid by an arm’s length party.
  • A transfer pricing penalty of 10% of the increase of taxable income was incurred for one of the years under examination.

Highlights of the Judgment:

  • The court rejected the “Amalgam” approach, where SII and SWI would be bundled together to test the Canadian effect of specified services. This was rejected on the basis it was contrary to the arm’s length principle and members of a multinational enterprise are to be treated as separate entities.
  • Establishing terms and conditions of related party transactions based on business experience, observation, and common sense was not accepted by the court to have fulfilled the documentation requirements of 247(4)(a)(v) and (vi) of the Canadian Income Tax Act.
  • The rejection of the “proof is in the pudding” argument, where significant success of the US operations occurred immediately after SII was engaged to provide these specified services. The court was not convinced that this business success was attributable to the contributions made by SII.
  • The reasonable efforts test was not met when the contemporaneous documentation consisted of a cover letter, legal agreements, copies of various correspondence, and a case study that all did not address how the terms and conditions of the related party transactions were determined. Even adding the sentence to the response “I trust the foregoing is the information you require. If you need any elaboration on the enclosed material please don’t hesitate to give me a call” was not “persuasive enough’ for the 247(3) reasonable efforts test. [Paragraphs 229 to 231 of the judgment].


4: Transfer Pricing Jurisprudence Update: McKesson’s Memorandum of fact and law: 

McKesson appealed the 2013 Tax Court of Canada decision that upheld the CRA’s transfer pricing adjustments which reduced the discount rate on an accounts receivable sale to a related party from 2.206% to 1.013%. In the recently filed Memorandum of fact and law, McKesson forwards the position that the judge made a “fundamental error of law” and requests the appeal be allowed with costs and the matter be remitted to the Tax Court for a new trial before a different judge. The Memorandum claims that the judgment was based on key factual findings that were not raised in the assessment or put in issue at trial, and that the resulting discount rate of 1.013% is an absurd result. This will be an interesting case to follow on how the facts drive the transfer pricing determination of an arm’s length range.