Transfer pricing perspectives: Winds of Change - PwC

The recent decision of the Tax Courtof Canada (“TCC”) in Alberta PrintedCircuits Ltd. v. The Queen included someinteresting observations regarding risks42 Transfer Pricing Perspectives. October 2011Perspectives on risk from CanadaThe Canada Revenue Agency (CRA) wasactively involved in developing Chapter 9of the OECD Guidelines, but it is too soonto tell how it will interpret and apply thisguidance. That said, the CRA has statedthat business restructuring is a primaryarea of focus, and this is evident from itsaudit activity. Subsection 247 (2)(b) ofCanada’s Income Tax Act actually gives theCRA a specific statutory tool (in additionto a broad General Anti-Avoidance Rule)to support “re‐characterisation”. Thissubsection, which has been actively usedby the CRA since its introduction in 1997,addresses transactions that “would nothave been entered into between personsdealing at arm’s-length” and, in certaincircumstances, authorises the CRA toamend these to transactions “that wouldhave been entered into between personsdealing at arm’s-length” under arm’s-lengthterms and conditions. As of June 2011,48 re‐characterisation cases have beenconsidered (such cases must be reviewedand approved by a senior CRA committeebefore they can be pursued by auditors),with 11 assessed and 10 ongoing. It is ourexperience that the allocation of risk istypically an important factor in these cases;audits routinely probe where risks aretruly borne and whether the ‘risk-bearer’has the financial capacity and managerialsubstance to bear the risk.However, even with Chapter 9 in hand asa defence, taxpayers should be aware thatthe CRA strongly endorses a transactionalapproach to transfer pricing. For example,a “risk-transfer payment” that reduces aCanadian entity’s profit to a certain levelmust be strongly supported by evidenceof the arm’s-length nature of the actualpayment (i.e. matching the payment withwhat the payment is for) rather than relyingon a TNMM analysis to support the profitleft behind in Canada.The recent decision of the Tax Court ofCanada (“TCC”) in Alberta Printed CircuitsLtd. v. The Queen included some interestingobservations regarding risks. The caseinvolved Alberta Printed Circuits Ltd.’s(“APCI Canada’s”) payment of service feesto a related company in Barbados (“APCIBarbados”). The TCC found that APCIBarbados (as a captive service provider)bore the biggest market risk because ithad only one customer (i.e. APCI Canada,the service recipient), leading the TCCto conclude that APCI Barbados couldnot be an appropriate tested party forapplication of the TNMM. As this scenariois common in related party transactions,a careful analysis of the balance of risksin service-provider transactions should beincluded in any Canadian transfer pricingdocumentation. Further, because theCRA places a lot of weight on the terms oflegal agreements, companies that want togenuinely transfer the significant risks ofa service provider should ensure that therelevant intercompany service agreementdoes achieve this risk transfer. For example,in the event of a closure (e.g. if servicesare no longer required), agreeing that theservice recipient is responsible for closurecosts is one step to support a lower riskprofile for the service provider.