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Suggestions for Drafting Tax Indemnity Clauses To Reduce Exposure to Unexpected Withholding Tax Obligations

There are an increasing amount of banks getting involved in loan syndications.  One of the reasons why syndications are attractive to banks is because they allow lenders to decrease exposure to losses, which will result from a borrower’s default, by bringing other lenders into either direct or indirect lending relationships with borrower.[i]  In addition, the bank can also increase its return on assets if fees are shared between multiple lenders.[ii] 

Generally, from the borrower’s perspective whether the loan is a single lender or syndicated lender loan the results are the same.  However, after the credit facility has been executed, the bank can make some changes to the parties to the agreement that may increase the tax burden of the loan.  Two examples of when this may arise are:

1.      where a non-resident is granted a participation in a loan that was originally executed between the borrower and resident lenders; or

2.      where the loan is assigned to a non-resident.   

Tax indemnity clauses are often used to apportion these increased costs.  Normally, these clauses require the borrower to bear the burden of the increase in costs by grossing-up their payments so that the amount received by the lender is equal to the amount lender would have received.  The increase to the borrower’s gross up obligation will make the cost of the financing more expensive for the borrower. 

In participations, lenders have an indirect relationship with the borrower.  Essentially, the bank initiating the transaction sells an undivided percentage interest to other lenders.  The interest sold to the other lenders includes the present and future obligations of the borrower.[iii]  Generally, participations are treated like a transfer of beneficial interest.  One author describes the participation and potential tax consequences where non-resident participants are involved as follows: 

There are two separate payments of interest in such a transaction: the borrower pays interest to the lead bank and the lead bank pays interest to the participants.  This arrangement … presents a relevant issue for withholding tax purposes.  On the one hand, the arrangement may be seen as two separate loans with two separate obligations to pay interest – one loan is from the participant to the lead bank, and the second loan is from the lead bank to the participant.  The two possibilities may result in different liabilities for the payment of withholding tax[iv]

Although the lead bank, operating as agent is responsible for paying the withholding tax in this situation, the Act does not exempt the participant from withholding tax requirements.  The result is that the borrower’s cost of borrowing is increased by withholding tax that is applied twice to the same transaction.

A further issue arises because the borrower may not aware of the transfer.  Where a Canadian resident borrower initially enters into a loan facility where all the lenders are resident in Canada the borrower makes payments based on the lender’s Canadian residency.  Where a participation is granted to a US lender, the Agent is required to withhold taxes[v] for any payments made to a non-resident.  The withholding tax amount is generally passed on to the borrower under the tax indemnity gross-up clause in the loan agreement.  Where the agreement does not require the lender to notify the borrower of this change the borrower is sometimes not aware of this increased tax obligation.  From the borrowers perspective this is an unfair result.  In most situations, although, the facility may have provided the lender with the option to enter into a participation agreement, it likely did not contemplate a transfer of interest to a non-resident.  For this reason the borrower should negotiate to include language in the tax indemnity that requires the lender to notify the borrower when a non-resident is granted a participation interest.

An assignment also creates tax issues for a borrower where the assignee is a non-resident.  In an assignment, the initiating bank assigns a contractual interest in an existing loan agreement to another bank.  The assignee bank will be in a direct relationship with the borrower after the assignment.  For this reason, the borrower must be notified of this change.  A basic assignment clause generally provides as follows:

Each bank may at any time assign or transfer all or part of its rights or obligations hereunder without the prior written consent of the Borrower to any other bank or financial institution.  Each Bank shall promptly thereafter give notice thereof to the Agent who will then forthwith give notice thereof to the Borrower.  Each Bank may disclose to any potential assignee or to any person who may otherwise enter into contractual relations with such Bank in relation to this Agreement, such information about the Borrower as such Bank shall consider appropriate.[vi]

Similar to the participation, where a loan has been assigned to a non-resident, the borrower’s withhold tax obligation is increased, unless an exemption applies.  To ensure that the lender's risk is not increased, the borrower must gross-up the amount paid under the tax indemnity clause.  Although, the borrower is required to be notified of an assignment they have little control over whether the assignment is to a resident or non-resident.  This is problematic since the ultimate burden for the increased withholding tax obligation is the borrower’s responsibility.  To reduce its exposure to increased tax liability in these situations, it is recommended that a borrower negotiate to have the following terms included in a tax indemnity clause: 

1)      No gross up permitted unless there is an event of default:  Requirement to gross up should only apply if there is a continuing event of default or the borrower provided consent, otherwise transaction should be structured so no withholding tax will apply; 

2)      Lender does not have the ability to assign interest if it increases cost to the borrower;

3)      Where the borrower was not notified of its withholding tax obligation, or the lender did not contest an assessment, the borrower should have the right to appeal a withholding tax assessment and any related penalties that have accrued as a result of assignment or participation.

4)      Where the lender receives tax credit for foreign taxes paid, the borrower costs of borrowing should be reduced by the same amount.  Lender actually incurred no loss by paying WHT just a timing difference for the payment. 

Issuances of a Letter of Credit (“LOC”) through a syndicated group of lenders may also increase tax obligations where any of the parties are non-residents.  LOC commitment fees are deemed to be interest payments under subparagraph 214(15)(b) of the Act.  The provision states:

where a non-resident person has entered into an agreement under the terms of which the non-resident person agrees to lend money, or to make money available, to a person resident in Canada, any amount paid or credited as consideration for so agreeing to lend money or to make money available shall, if the non-resident person would be liable to tax under this Part in respect of interest payable on any obligation issued under the terms of the agreement on the date it was entered into, be deemed to be a payment of interest

The rule generally applies where only one LOC is issued and the lead lender resides in one jurisdiction but the fee is divided equally between syndicated lenders residing in different jurisdictions.  However, this will be decided on a case-by-case basis.[vii]

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[i] P. Lewarne and K. E. Thorlakson, “Syndications, Assignments and Participations by Canadian Banks”, 6 BFLR 1 at 2.

[ii] Lewarne and Thorlakson at 2.

[iii] See Lewarne and Thorlakson at 2

[iv] A. Mugasha, “The Law of Multi-Bank Financing: Syndications and Participations”, (Kingston, Ont: McGill-Queen’s University Press) at 297.

[v] See section 215(3).

[vi] D. Desjardin, “Assignment and Sub-participation Agreements – A Basic Overview”, [1986] 65 Can. Bar Review 224 at 231

[vii] See Revenue Canada Document 2003-0014145 where the letter of credit was found not to be subject to subparagraph 214(15)(b).


Transfer Pricing Issues Related to Cross-Border Guarantees

The CRA holds the view that where a guarantee is provided by a Canadian corporation without charging a guarantee fee the transfer pricing rules will apply.[i]  It is the CRA’s position that providing a guarantee is equivalent to a guarantor performing a service to the debtor.  Initially, the authority for this proposition was Melford Developments v. The Queen[ii] where the court held that a guarantee provided in the ordinary course of business and any related fees were for services provided by the corporate taxpayer.  More recently, however, the Minister relies on the transfer pricing rules.  The transfer pricing rules permit the Minister to re-characterize a guarantee to reflect the amount of a fee that would be payable if a similar agreement was entered into between parties dealing at arm’s length.  The Minister can only re-characterize the guarantee in the following circumstances:

  • if it can be determined that the terms of the guarantee agreement differ from those that would have been made between parties dealing at arm’s length, or
  • the guarantee would not have been entered into for bona fide purposes other than to obtain a tax benefit.[iii]

Where these rules apply, the Minister treats the value of the guarantee service provided as a taxable benefit[iv] and the value of an equivalent arm’s length fee that would have been paid for providing the service is imputed as income to the guarantor. 

Again, there is no definitive authority on how these rules apply in practice.  However, it has been argued that the provision will not apply to members of a corporate group if it is determined that the guarantee was provided primarily for a commercial purpose and not to obtain a tax benefit.[v]  Also, the rules may not apply where the subsidiary is very solvent and the guarantee is required as part of a credit agreement.[vi]  Further, it could be argued that the guarantee is not the type of transaction arm’s length parties would enter into, therefore, the transfer pricing rules should not apply.[vii]

In the event that the transfer pricing rules apply the taxpayer must determine arm’s length price as a comparable for determining the imputed value of the guarantee.  There a various methods for determining an arm’s length price under the transfer pricing rules.  However, the Minister has endorsed two acceptable methods of valuation.  First, the taxpayer can determine what an arm’s length financial institution would charge as a guarantee fee in the circumstances.  Although, this is the easiest method, it could yield inappropriate results because the particular financial institution’s credit strength, relative to the Canadian corporate guarantor, and its ability to spread the risks over a number of similar obligations may be different than the guarantee in question.  Another alternative is to assess the present value of the reduced financing costs that arise from the guarantee.  It would appear that the value of any shareholder benefit or imputed guarantee fee should, for Canadian tax purposes, be limited to the debtor’s reduced cost of financing as a result of the guarantee.  However, this is not a position the Minister completely endorses.[viii]   

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[i] See Revenue Canada Document #1999-0010070, Tax Executives Institute Liaison Meeting, December 7, 1999.

[ii] 80 DTC 6074 (F.C.T.D.).

[iii] See section 247(2).

[iv] See Canada Revenue Agency document #9206635.

[v] R. Tremblay and J. Fuller, “Tax Consequences of Cross-Border Guarantee Fees”, International Tax Planning , page 715 at 719.

[vi] R. Tremblay and J. Fuller, Tax Consequences of Cross-Border Guarantee Fees, International Tax Planning, page 726 at 719.

[vii] B. Sinclair and R. Kopstein, “Guaranteed to Enlighten: The Impact of Guarantees on Financing Arrangements, Canadian Tax Journal.

[viii] B. Sinclair and R. Kopstein, “Guaranteed to Enlighten: The Impact of Guarantees on Financing Arrangements, Canadian Tax Journal.


A Guaranteed Shareholder Benefit for Cross-Border Loans

Oftentimes, third party loans received by multi-national enterprises require one of the parties of a corporate member group to guarantee the loan of another.  A guarantee is basically a promise by one party, the guarantor, to fulfill another party’s, the principal’s, financial obligations under a credit facility.  Generally, the guarantor only becomes liable for any outstanding payments related to the debt if the principal defaults on the loan.  However, the guarantor may be exposed to immediate tax liabilities before an event of default where the guarantor resides outside the borrower’s taxing jurisdiction. 

For example, under the Income Tax Act (Canada)[i], a guarantee provided by a Canadian corporation to secure a loan for a related non-resident shareholder might be treated as a shareholder benefit to the benefactor of the guarantee.  Where the guarantee is treated as a shareholder benefit, the non-resident is deemed to have received a dividend and must include the amount of the dividend in calculating its income for the year.[ii]  The deemed dividend will be subject to a 25% withholding tax rate[iii] as if the Canadian corporation had initially declared and paid it.[iv]  The tax policy behind this rule is to prevent a shareholder from avoiding tax by removing surplus from a Canadian subsidiary by way of a guarantee instead of paying a dividend.

Because of the adverse tax consequences, taxpayers are very concerned about when this rule may apply.  The Act does not define benefit and the common law only provides minimal guidance.  For example, in Youngman v. The Queen the court stated:

There is no definition of “benefit” or “advantage” in the Act and the words are thus capable of the broadest possible interpretation.  Nor is there any simple, prescribed formula for resolving any question of shareholder benefit within the meaning of section 15(1)(c).  Essentially, each case must be decided on its own particular facts[v]

To assist shareholders and provide certainty about the application of this rule, the CRA has issued technical interpretations that help to clarify when a shareholder benefit may exist as a result of a guarantee.  For example, in one Technical interpretation the CRA expressed the view that if a guarantee is provided as a requirement of obtaining a loan and amounts are advanced to Canadian subsidiary at the same time, there likely would be no shareholder benefit.  Further, where a US corporation guarantees the debts of a Canadian parent, the CRA may also impute a shareholder benefit to the Canadian parent under the same rule.  In this situation, withholding taxes will not apply to the guarantee fee that would be deemed to be paid by the Canadian parent to the US corporation.[vi]

In commenting on whether a shareholder received a benefit from a guarantee of a loan for a subsidiary, CRA expressed the view that there was a benefit if the only reason the shareholder guaranteed the loan was to protect its investment.[vii]  In circumstances, however, where a guarantee is given for a loan of an arm’s length shareholder, CRA will not assess a benefit unless it was reasonable to believe that the shareholder could not repay the loan at the time the guarantee was granted.[viii]

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[i] All statutory references are to the Income Tax Act, R.S.C. 1985, c. 1 (5th Supp.), herein referred to as “the Act”.

[ii] See subsections 15(1).

[iii] Unless reduced under the treaty.

[iv] See subparagraph 214(3)(a), which is interpreted to deem a payment to be made for purposes of applying withholding tax.  Also see article by Rossiter, J. entitled “The Application of Part XII Nonresident Withholding Tax to Deemed Payments”, (1986) 34 CTJ 511 for a discussion on how the withholding tax is applied to deemed payments under 15(1) and 15(2).

[v] 86 DTC 6584 at 6587 (FCTD).  Also see Cooper v. The Queen 88 DTC 6525 at 6534; and Revenue Canada Document # 9205665.

[vi] Revenue Canada Document #1999-0010070, Tax Executives Institute Liaison Meeting, December 7, 1999.

[vii] Technical interpretation of the Business and General Division, August 27, 1990, in Claude Desy, ed., Access to Canadian Income Tax (Markham, Ont: Butterworths) looseleaf, paragraph C9-068.

[viii] Technical interpretation of the Reorganizations and Foreign Division, July 29, 1992, In Windows on Canadian Tax (Don Mills, Ont.: CCH Canadian) (looseleaf) paragraph 2043.


Global Video Inc. Gets No Credit

One of the ways in which the Canadian government has tried to maintain cultural programming in film and television is by providing tax incentives that are focused on rewarding film producers who develop programs with significant Canadian cultural content.  Many film producers rely on these tax incentives to allow them to make films they otherwise would not be able to make because of limited resources and funding.  However, to qualify for this funding, producers should be careful to ensure that certain requirements are met.  If they don’t, they may find that they are responsible for paying the entire production cost like what happened to the taxpayer in Global Video Inc. v. The Queen.[i]

Section 125.4 of the Income Tax Act (Canada)[ii], provides film producers with a refundable tax credit of 25% of qualified labour expenses[iii] incurred when making a film. To be eligible for this credit the film must be made by a qualified corporation and certified as a Canadian film or video production (“CFVP”) by the Canadian Audio-Visual Certification Office (“CAVCO”).  One of the main objectives behind offering the credit is to provide an incentive for Canadian film producers to make films with a focus on Canadian content.  The credit is also administered to ensure that Canadian producers maintain a beneficial interest and a strong position of control over their productions.[iv]  Being certified as a Canadian production is based on the number of key positions in a production that are filled by Canadians.  In addition, salaries and wages paid to Canadians must account for at least 75% of the total cost of production to be certified.  Presumably, once a film is certified it should have access to the tax credit under 125.4.  However, this is only the first hurdle.  The company producing the film must also be a qualified corporation to be eligible for the credit.  This was the issue in Global Video.

In Global Video, the taxpayer Global, a Canadian corporation, was a film production company established in 1996.  Global’s business was focused on the production of documentaries and advertising films.  In September 2001, the corporate taxpayer received a Canadian film production CFVP certificate for the production that is the subject of this case.[v]  After receiving the certificate Global began filming with the expectation that the production would be eligible for the CFVP tax credit.  Accordingly, in filing its tax return for 2001, Global claimed production costs of $125,047 for the film and a corresponding tax credit for $15,006, 25% of the labour costs associated with the production.  Global’s total production cost for the year was $435,669.  The Minister denied Global’s CFVP tax credit claim.  Global appealed to the Tax Court of Canada.

The Minister argued that Global was not a qualified corporation because it did not primarily carry on a CFVP business as required under the Act.  A qualified corporation is defined under the Act as:

… a corporation that is throughout the year a prescribed taxable Canadian corporation the activities of which in the year are primarily the carrying on through a permanent establishment (as defined by regulation) in Canada of a business that is a Canadian film or video production business.[vi]

The Minister determined that the subject production was Global’s only Canadian film or video production for the year.  Further, since Global’s total production cost for the subject production was only $125,047, which accounted for less than 30% of the total production costs of the company, it did not meet the qualified corporation definition since the CRA generally interprets primarily to mean more than 50%.[vii]  Although both parties agreed with the Minister’s interpretation of primarily they disagreed on what criteria it should be applied to.  The Minister considered all sources of revenue generated by a corporation.  Global, on the other hand, believed that the determination should be made based on the total costs of a particular production. Global argued that the Minister’s application of 125.4(1) was too restrictive and that it created inequitable results.  In essence, Global’s position was that the interpretation presented by the Minister would require the incorporation of a separate entity solely for the purposes on producing certified productions, which would essentially permit the taxpayer to accomplish indirectly through a shell corporation what it could not do directly.  Global argued that if it did not meet the requirements it should be permitted to claim the credit on equitable grounds since subject production met the requirements under the definition. 

Judge Lamarre Proulx disagreed with Global.  The court found that the language of the Act clearly stated that the film production corporation is entitled to a credit under 125.4 if it primarily conducts a CFVP business.  Judge Lamarre Proulx went on to say that the general rule for interpreting a statute requires that the courts use the plain and ordinary meaning of the words in a statute where they are clear and unambiguous.  In support of this proposition, the Judge referred to the Supreme Court of Canada’s decision in Canada Trustco Mortgage Co. v. Canada where the court stated:

Where the words of a provision are precise and unequivocal, the ordinary meaning of the words play a dominant role in the interpretive process.

Where Parliament has specified precisely what conditions must be satisfied to achieve a particular result, it is reasonable to assume that Parliament intended that taxpayer’s would rely on such provisions to achieve the result they prescribe.[viii]

Presumably, where separate records are kept for each type of production, those that qualified for the credit could be justified in making a claim if the appropriate labour costs can be attributed to each production.  However, the Act clearly states that the credit is based on the corporation’s activities.  The Act does not provide an assessment based on individual productions.  This was likely the intention of Parliament.  The provision was likely worded in this way to limit opportunities for abuse. Accordingly, based on the literal interpretation of the provision, the Minister’s assessment and the Tax Court of Canada’s decision were correct.  Global did not produce any evidence to indicate that a purposive interpretation of the section was required.  Nor did they provide an alternative criteria for determining that the primary purpose of their company’s business was to produce CFVP throughout the relevant taxation year.      

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[i] 2005 DTC 1818.

[ii] R.S.C. 1985, c. 1 (5th Supp.).  All references in this article to the Act are to the Income Tax Act unless otherwise stated.

[iii] The credit claim is limited to 12% of the total production cost.

[iv] See Canadian Heritage website, Canadian Audio-Visual Certification Office:  https://www.pch.gc.ca/progs/ac-ca/progs/bcpac-cavco/pubs/2001-02/ra-ar/prog_e.cfm#3.1.1 (Accessed: April 17, 2006)

[v] The taxpayer also obtained a similar certificate from the Societe de developpement des enterprises culturelles (“SODEC”).  The criteria for granting a credit on the basis of this certificate will not be discussed in this case comment.   

[vi] See definition of  “qualified corporation under section 125.4(1).

[vii] See Guide to Form T1131 entitled “Claiming a Canadian Film and Video Production Tax Credit”

[viii] 2005 DTC 5547.


Making a Reasonable Effort to Comply with Canadian Transfer Pricing Rules

Under section 247(3) of the Income Tax Act (Canada) (the “Act”), the Minister can impose a penalty on a taxpayer that does not comply with Canadian transfer pricing rules.  The penalty applies to the total net transfer pricing income that exceeds the lesser of $5 million and 10% of the taxpayer's gross revenue for the year.  The provision permits the Minister to make an adjustment to the total net transfer pricing income where the taxpayer has made reasonable efforts to determine and use arm’s length prices.  According to the Canada Revenue Agency (“CRA”) Information Circular 87-2R, the intention of the policy is to ensure compliance.  Therefore, where it can be demonstrated that the taxpayer made a reasonable effort to determine the appropriate transfer price the Minister’s practice is not to apply the penalty.  Reasonable effort is determined on a case-by-case basis. 

Despite best intentions to comply with the Act, a taxpayer may be deemed not to have made a reasonable effort pursuant to subsection 247(4), if they have not produced appropriate records or documentation of their efforts.  The Act requires that this information should be filed within six months of the company’s year-end or 90 days from a date a request for the information is made from the Minister.  The information provided must present an accurate description of the following: 

1.      property or services to which the transaction relates;

2.      terms and conditions of the transaction and their relationship to any other transaction entered into between the parties;

3.      identity and relationship of the parties to the transaction;

4.      functions, risks and property or services used or contributed by each party;

5.      description of the method used to determine arm’s length pricing, the allocation of profits or losses, or contribution to costs

The taxpayer’s documentation should also include a general description of the business.  The Minister also expects the taxpayer to compare the benefits projected to the actual benefits realized.  In the transfer pricing IC, the CRA notes that hard bargaining is not sufficient evidence for establishing an arm’s length price.  The CRA also advises that documentation should include any relevant foreign-based documents that may be helpful in assessing the appropriate arm’s length price. 

Companies carrying on business with non-arm’s length entities are also required to file a return providing details of foreign business activity pursuant to section 233.1. Also, companies must file a Form T106, which is used by the CRA to screen non-arm’s length transactions for review and audit.  A company will be subject to penalties if the return is not filed on a timely basis.

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Overview of CRA’s policy on the Arm’s Length Principle in Transfer Pricing

According the Canada Revenue Agency ("CRA") Information Circular 87-2R, the arm’s length principle under the transfer pricing rules governed by section 247 of the Income Tax Act (Canada) requires that the terms and conditions agreed to between non-arm’s length parties should be compared to an agreement that would result between parties dealing at arm’s length. The CRA circular relies on the Organization for Economic Co-operation and Development ("OECD") transfer pricing guidelines for criteria to be used in determining comparable arm’s length prices in a transaction.

The OECD guidelines provide that the arm’s length principle, generally, is based on a comparative price analysis. The guidelines state the economically relevant characteristics of a transaction must be "sufficiently similar" to the transaction in question. The OECD advises that only transactions between non-arm’s length parties should be used for this comparison. The factors that should be considered in determining whether the uncontrolled non-arm’s length transactions are comparable to the subject transaction are as follows:

    1. Characteristics of the property being purchased;
    2. Functions performed by the parties to the transaction;
    3. Economic circumstances of the parties, and
    4. Business strategies pursued by the parties

The guidelines suggest that this analysis should be conducted on a transaction-by-transaction basis. Transactions should only be assessed as a group for compliance with transfer pricing rules where they are so closely related that they cannot be logically separated for purposes of the analysis. The OECD provides six recommended methods for determining appropriate arm’s length prices to be used in transfer pricing analysis. The first three methods can be characterized as traditional transaction methods. They are:

    1. comparable uncontrolled price (CUP)
    2. resale price
    3. cost plus

The other group can be characterized as the transactional profit methods. These include:

    1. profit split
    2. transactional net margin
    3. other

Continue reading "Overview of CRA’s policy on the Arm’s Length Principle in Transfer Pricing" »


Managing the Competitiveness of Multinational Corporations: Transfer Pricing Rule Fundamentals

The global marketplace has created many concerns for multi-national enterprises (“MNEs) conducting business outside of their home jurisdiction.  One significant concern for such a business is the impact of foreign and domestic tax laws on its worldwide activities.  In particular, a MNE conducting business in multiple jurisdictions may be exposed to a high global tax burden, which inevitably reduces shareholder profit.  To counter this effect, many MNEs have developed structures that help minimize exposure to double taxation and total global tax burden.  Some governments, including Canada, may perceive such strategies as a threat to their local tax base and, accordingly, have implemented rules that will limit the benefit of such planning. 

The objective of the Canadian transfer pricing rules is to protect the Canadian tax base.  The transfer pricing rules are applied to ensure that a MNE is paying the appropriate amount of tax in Canada.  This determination is based on the standards of an arms-length transaction in the particular situation.  A company that does not comply with Canadian transfer pricing rules may find that it is exposed to increased corporate tax liability, double taxation and penalties and interest.  For this reason, it is important to consider the application of these rules before establishing a business in a foreign jurisdiction.

Section 247 of the Income Tax Act (Canada), (the “Act”) the transfer pricing provision, provides that where the terms and conditions of a transaction between non-arm’s length members of a related group differs from the terms that would exist between arm’s length individuals, the offending amounts can be adjusted to reflect conditions that would exists in a non-arm’s length transaction pursuant to 247(10).  Further, under 247(2) a transaction will be re-characterized to reflect the non-arm’s length expectations of an agreement as if the transaction entered into was one that would not have been entered into by arm’s length parties.  Also, another condition for re-characterizing the transaction is that it must be demonstrated that the primary purpose was to obtain a tax benefit and not a bona-fide reason.  247(3) of the Act provides the government with authority to levy a penalty if the readjustment exceeds the lesser of 10% of the taxpayer’s gross revenue for the year and $5 million. In order to avoid the imposition of a penalty, the taxpayer must demonstrate that made a reasonable effort to determine the arm’s length price for a particular transaction.  However, the Minster has the discretion to deem the taxpayer not to have made a reasonable effort unless certain specified conditions under 247(4) have been met.  The provision requires that the taxpayer provide relevant documents and records within three months after they receive a request from the Minister.  These provisions, generally, apply to transactions entered into after 1997, with a few applicable only to transactions after 1998.

Canada Revenue Agency (“CRA”) has published Information Circular 87-2R, entitled, “International Transfer Pricing”, to provide guidance to MNEs with respect to compliance requirements under this provision.    It is worth reviewing to get a better understanding of the expectations that might be imposed on a MNE under these rules.  MNEs must also consider transfer-pricing rules of the foreign countries in which they are conducting business.  Although, the practice has been to prepare relevant documentation on a country-by-country basis, it is now acceptable to provide global documentation that will coordinate the collection of common transfer-pricing information with specific discussion addressed to a particular country’s requirements.

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