A recent transfer pricing case from the Tax Court of Canada
(McKesson Canada CorporationvThe
Queen) establishes a broad interpretation of the
"regular" (non-recharacterization) transfer pricing rule
in the Income Tax Act and offers guidance on the adequacy
of contemporaneous documentation. It is therefore an
important case for multinationals doing business in Canada.
In McKesson, the Canadian taxpayer entered into a
factoring arrangement with its Luxembourg parent in which it sold
$460 million of trade receivables to the parent and entered into a
five-year agreement to sell future receivables up to a $900 million
cap. As is typical in factoring arrangements, the taxpayer
sold its receivables at a discount to face. At issue was the
quantum of the discount: the taxpayer used a formula that yielded a
2.206% discount in the year in question but Canada Revenue Agency
(CRA) asserted an arm's length rate would have been
1.013%. (McKesson's traditional loss rate on receivables
had been 0.043% before the factoring arrangement.) In a
lengthy decision, Justice Boyle ruled against the taxpayer.
An appeal has been filed.
One of the key issues in the case was the extent of adjustments
that are permitted under the "regular" transfer pricing
rule in s247(2)(a) and (c) of the Act (vs. s247(2)(b) and (d),
which permit recharacterization of a taxpayer's transactions,
but only in the absence of a bona fide non-tax purpose and
on which CRA did not rely in the McKesson case). The
Court held that these provisions permit adjustments to the quantum
or nature of an amount used by a taxpayer to reflect what the
quantum or nature would have been if the terms and conditions
(including those not directly incorporating an amount) were
arm's length. Applying this interpretation, the Court
rejected the parties' approach of fixing certain elements of
the discount for the full term of the agreement (although the
agreement so provided) in favour of an amount consistent with a
shorter term, floating rate. This is one of the grounds of
the taxpayer's appeal.
The Court also delivered a warning to taxpayers that
contemporaneous documentation that is a partisan attempt to justify
the most advantageous transfer price, rather than reflecting a
balanced assessment of the positions of the parties, should not
meet the contemporaneous documentation standards in the Act and
should not protect against penalties. We can expect that CRA will
take this admonition seriously and taxpayers should carefully
consider the adequacy of their transfer pricing documentation.
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
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