Canada: BEPS Cash Box Inconsistent With Canadian Tax Rules

The BEPS project's new transfer-pricing notion of "cash box" appears to be inconsistent both with commercial reality and with longstanding Canadian outbound international tax policy.

In 1976, Canada adopted the policy of facilitating management (reduction) of the foreign tax obligations of Canada's multinational enterprises (MNEs) via group financing and licensing arrangements, carving those obligations out of the FAPI system. The primary mechanism of this carve-out was and remains subparagraph 95(2)(a)(ii), which converts passive inter-FA interest or royalty payments out of the payer FA's ABI into the recipient FA's ABI. This system survived an indirect challenge in 2007, when the anti-double-dipping rule in section 18.2 was enacted (but repealed in 2009, before its effective date), and it was strongly endorsed by the 2008 governmentappointed Advisory Panel on Canada's System of International Taxation.

The integrity and effectiveness of subparagraph 95(2)(a)(ii) may now be coming under another indirect attack, a result of the OECD's BEPS transfer-pricing theory for so-called cash boxes and the consequent taxation of income of a group financing or licensing company (or, more accurately, taxation of the sharing of the income among multinational group members). This article explains the BEPS cash-box theory, why it is invalid, and why it should therefore not apply in Canada.

The BEPS cash box disregards commercial reality. Actions 8-10 of the BEPS report, which make up the transfer-pricing approach, contain a cash-box notion: the stated purpose of that report is to align transfer-pricing outcomes with value creation while retaining and working within the confines of the arm'slength principle. The OECD defines cash boxes as "shell companies with few if any employees and little or no economic activity, which seek to take advantage of low or no-tax jurisdictions"; the cash box thus contemplates a group member that simply provides capital, such as funding or intangibles, for use by an operating company and that itself has limited activities. The OECD asserts that "[i]f the capital-rich member does not in fact control the financial risks associated with its funding, then it will be entitled to no more than a risk-free return, or less if, for example, the transaction is not commercially rational and therefore the guidance on non-recognition applies," and it similarly says, with respect to intangibles, that "[l]egal ownership of intangibles by an associated enterprise alone does not determine entitlement to returns from the exploitation of intangibles."

These OECD statements essentially suggest that economic returns in excess of a risk-free return are (or should be) attributable to labour and not to capital; furthermore, they suggest that excess economic returns are only allocable to an entity if its own employees perform the specific economic functions and it does not outsource functions to other group entities or external providers. The OECD statements are not supported by the arm's-length principle and are inconsistent with economic theory and practice.

According to the cash-box notion, the allocation of the risk from loans and licences between group members of MNEs— and hence the related profit—must be made on a factual basis and not a contractual basis. That process is said to have two actors: the party that has the "control over the risk" and the party that has the financial capacity to bear the risk of the loan. The first party's control appears to mean merely the decisionmaking authority to make a loan, but investors may routinely hire professionals to perform the task. Can the second party be other than the lender that puts up its money to make the loan? In any event, it is difficult to interpret those factors in such a way as to arrive at the OECD's conclusion that the lion's share of the profit from the intercompany loan or licence is allocable to group members as a whole and not to the group lender or licensor, which is allocated only "risk-free returns" (that is, three-month treasury bill rates). Thus, according to the OECD, if the lender or licensor does not employ persons to make and manage its investments but turns to group members to help out, it may not be entitled to the main portion of the income from the loan or licence.

Economic theory and practice arrive at a different conclusion. As a matter of practice, passive investors routinely engage financial advisers and asset managers, but they do not merely keep a risk-free return for themselves and pay the balance to the advisers. For example, the best-paid private equity fund managers receive no more than 20 percent of the income earned by the totally passive money-owning investors. The cash-box notion does not reflect that reality and is inconsistent with transfer-pricing policy, which is intended to mirror economic and business reality whenever possible.

In summary, the OECD's changes to its BEPS transfer-pricing guidelines seek to erode the arm's-length principle by promoting inconsistent exceptions, such as for cash boxes. The OECD's focus on labour appears to adopt a formulary apportionment that is based on salaries and wages. Therefore, it is not surprising that, last year, Justice Frank J. Pizzitelli of the TCC described the OECD's final package on BEPS as a step toward formulary profit attribution principles, and he said that the trend was likely to continue. In our view, the BEPS approach is also inconsistent with the Canadian policy reflected in subparagraph 95(2)(a)(ii).

In Canada's 2016 budget, Finance took the unusual step of saying that the CRA was then applying the revised OECD guidance on transfer pricing, which "provides an improved interpretation of the arm's-length principle." Significantly, however, Finance also said that the CRA would not adjust its administrative practices at that time in the two most controversial areas of the OECD's BEPS-related transfer-pricing work: the proposed simplified approach to low value-adding services and the treatment of cash boxes. Canada will decide on a course of action with regard to these measures after the OECD completes its followup work.

It should be reiterated that in the seminal transfer-pricing case of GlaxoSmithKline (2012 SCC 52), the SCC said that the OECD's transfer-pricing guidelines "are not controlling as if they were a Canadian statute and the test of any set of transactions or prices ultimately must be determined according to [Canada's transfer-pricing legislation] rather than any particular methodology or commentary set out in the Guidelines." The Canadian arm's-length principle is legislated in section 247 and thus any inconsistent OECD pronouncements—even those adopted as CRA administrative practice—are likely to fail in proceedings before a Canadian court.

The CRA and Finance should reject the notion of the cash box's relevance to Canadian tax law. However, comments made by Michelle Levac (transfer-pricing specialist at the CRA) at a transfer-pricing conference held in Toronto on August 30, 2016 appear to be inconclusive. Levac, who previously served as chair of the OECD's Working Party 6, said that the OECD transferpricing report recognizes the importance of funding "and the contributions of cash or capital." Levac went on to say, however, that there had been no "sea change" in the BEPS limitations attached to a cash box that funds intangible development but whose only economically relevant activities result in a risk-free return.

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.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

Disclaimer

Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

Registration

Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

Cookies

A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

Links

This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

Mail-A-Friend

If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

Security

This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.