Charting The Strategic Path Through A Transfer Pricing Dispute

a) Is there a tax treaty with the non-resident country?

While Canada has tax treaties with many countries, it does not have a tax treaty with every country. Where there is no tax treaty, domestic avenues of relief may be the only recourse available, as there is no way for any bilateral negotiation to provide relief from double taxation.

b) Is the CRA audit's position unreasonable?

Where the CRA audit position is unreasonable (for example, trying to attribute all system profits to Canada), and the taxpayer assesses a high likelihood of success in court, it can often be best to pursue domestic avenues of relief, and in some cases, bypass the CRA appeals process by going directly to the Tax Court of Canada. It can sometimes be futile to pursue treaty-based avenues for relief and have the two countries negotiate based on unreasonable transfer pricing adjustments.

Where the CRA audit position is within a reasonable range, it may be more advantageous to pursue treaty-based avenues of relief to reduce double taxation, as income will have already been taxed in the foreign jurisdiction.

c) Are transfer pricing penalties involved?

The CRA can impose transfer pricing penalties when it determines a taxpayer did not use reasonable efforts to determine arm's length prices. Transfer pricing penalties are not generally dealt with under the MAP. Domestic avenues of relief are the only recourse to reverse transfer pricing penalties, which are usually based on whether there is (i) reasonable contemporaneous documentation and (ii) reasonable and reproducible analyses provided to the CRA.

d) What are some other strategic factors to consider?

Even where there is a tax treaty in place, it may not be in the strategic best interest of the taxpayer to pursue treaty-based avenues of relief:

• Let sleeping dogs lie: A taxpayer may not want to alert the foreign tax authority about a transfer pricing issue because it may start an audit in the foreign country or increase scrutiny on the non-resident non-arm's length party who may have other more significant tax issues.
• No benefit to cash taxes: Where the non-arm's length party is in a loss position, pursuing treaty-based avenues of relief may not improve the cash tax situation. The increase in the transfer pricing adjustment to Canada, for example, may result in additional outlays of cash taxes, but there may not be a corresponding decrease in cash taxes in the foreign jurisdiction if the non-arm's length entity is already in a loss position.
• Little expertise or resources by the foreign competent authority: If the foreign competent authority has little expertise or resources in dealing with transfer pricing disputes and negotiating treaty-based relief, a taxpayer is likely not going to get a good result. Where a foreign competent authority has experience and resources in dealing with transfer pricing related treaty-based relief, it is easier for a taxpayer to equip that competent authority with ammunition to reverse or reduce the adjustments.
• Large corporations pay to play: For large corporations (taxable capital employed in Canada over $10 million), the CRA can collect up to 50% of the tax, interest, and penalties assessed even if a notice of objection has been filed. The Minister may accept a letter of credit in certain circumstances, avoiding the need for an immediate cash payment. If the taxpayer succeeds in either obtaining relief from double taxation or reducing the tax payable in court, the taxpayer can recoup interest on the amount held by the CRA.
• Both domestic and treaty-based avenues take time, have costs, and have risks:

The CRA appeals process generally takes 2 to 3 years. The Tax Court process generally takes 5 to 7 years, requiring transfer pricing experts, extensive documentary and oral discoveries, and a Tax Court hearing that may span weeks or months. One of the largest risks is that people who were involved in the transaction are no longer with the taxpayer many years later. The legal costs and disbursements in the recent Cameco transfer pricing case were about $57 million, with costs awarded to Cameco for only about $10 million (see 2019 TCC 92). The pleadings filed in the Tax Court are publicly available, and absent a confidentiality order, anything provided at the Tax Court hearing is publicly available.

The Department of Justice may raise a new argument that was not contemplated during the transfer pricing audit. For example, in the recent Lehigh Hanson Materials Limited decision, the issue before the Tax Court was the fair market value of a non-resident affiliate that was sold by a non-arm's length non-resident to a non-arm's length Canadian acquirer for consideration that included a note. The CRA reassessed on the basis that the fair market value was lower and thereby disallowed a portion of the interest on note (based on a lower principal amount of the note), without changing any other terms and conditions. The Tax Court allowed the Department of Justice to raise a new argument that the terms and conditions of the note differed from what would have been agreed between persons dealing at arm's length, questioning the interest rate on the note. This decision is currently under appeal to the Federal Court of Appeal.

The MAP process can take 2 to 3 years. According to the Mutual Agreement Procedure Program Report 2023, Canadian-initiated transfer pricing cases took 27.79 months on average. As negotiations in the MAP process are only between the competent authorities and thus very opaque, taxpayers are often left in the dark without being a party at the table. Taxpayers are required to either accept or reject the MAP agreement, without any input on its terms and conditions. Even after a MAP agreement is successfully concluded, there may still be issues to resolve with the CRA that can take additional time, including for example (i) deductibility issues, (ii) interest relief, (iii) foreign tax credits or (iv) additional penalties that the CRA may choose to impose.

In some tax treaties, there is a mandatory arbitration provision (e.g. United States and United Kingdom) that commences once a file is accepted into the MAP, helping to reduce the timelines.