Recent months have seen several revisions to the Canada Revenue Agency’s (CRA) administrative policies concerning transfer pricing, including in response to COVID-19, but the pandemic has also postponed any potential changes to the underlying tax law. In the meantime, the Federal Court of Appeal has denied the CRA’s attempt to apply on the transfer pricing recharacterization rules in the Cameco case.
The CRA’s Appeal of the Cameco Case was Denied
On June 26, 2020, the Federal Court of Appeal upheld the Tax Court’s earlier decision that Cameco Corporation’s transactions with its Swiss subsidiary had been on arm’s length terms, with no adjustments to income or tax required. The Court rejected the Crown’s arguments for reallocating profits within the Cameco group by restructuring its internal transactions. Instead, the Court held that the recharacterization provisions within Canada’s transfer pricing rules were not applicable in Cameco’s circumstances, and could only be applied to transactions that would not have been entered into between any two (or more) arm’s length parties, under any terms or conditions. The Court further held that the pricing of Cameco’s existing transactions was arm’s length.
The CRA’s Response to COVID-19
The Canadian government’s response to the COVID-19 crisis included several temporary measures that provided flexibility and relief to taxpayers, including extensions of certain tax return filing deadlines and the pausing of certain audit and tax collection activities. For example, deadlines for Canadian corporate tax returns for taxation years ended December 31, 2019, that would typically have been due June 30, 2020, have been extended to September 1, 2020. As a result, the deadline for the contemporaneous transfer pricing documentation required for penalty protection purposes was also effectively extended to the same date.
With many taxpayer employees and CRA officials working remotely during COVID-19, the CRA has also taken certain temporary measures to increase taxpayers’ ability to communicate with the CRA by email and video conference.
Potential Changes in Tax Law Postponed
Any changes to Canadian tax law are typically announced when the government presents the annual federal budget for approval by Parliament. However, the 2020 federal budget originally scheduled to be presented on March 30 has been postponed indefinitely. This may delay the introduction of new tax law, such as in response to the Organization for Economic Cooperation and Development’s (OECD) Programme of Work to Develop a Consensus Solution to the Tax Challenges Arising from the Digitalisation of the Economy, which included proposals grouped under Pillar One and Pillar Two.
With respect to the OECD’s Pillar One, Canada’s federal Liberal Party had announced (before it was re-elected on October 21, 2019) an intention to introduce a new percent tax on the “income of businesses in certain sectors of the digital economy”, focused on targeted advertising services and digital intermediation services.
Separately, the Liberal Party also proposed an interest deduction limit that would be based on the taxpayer’s interest expense to EBITDA in addition to current rules that limit interest deductions based on a debt-to-equity ratio.
No new date has been set for releasing the 2020 budget. Bill C-13, the COVID-19 Emergency Response Act, was tabled in the House of Commons on March 24, 2020, and extended the federal government’s ability to borrow and spend money through September 30, 2020. On June 17, 2020, Canada’s Prime Minister announced that a fiscal “snapshot” would be presented on July 8, 2020, but no timetable has been provided for the budget itself and it remains to be seen whether that budget will include provisions related to Pillar One or Pillar Two.
Transfer Pricing Policy Developments
A number of the CRA’s transfer pricing policy documents have been cancelled or revised in recent months.
The CRA’s administrative policy with respect to enforcing Canada’s transfer pricing rules had been summarized in Information Circular 87-2R, International Transfer Pricing (IC 87-2R). Effective December 30, 2019, the CRA quietly “cancelled” IC87-2R and moved it to an archive section of its website, without offering a replacement. According to a Notice to Tax Professionals released by the CRA on February 26, 2020, IC 87-2R was cancelled because it was inconsistent with the interpretation and application of Canadian transfer pricing legislation, and did not reflect updated guidance from the OECD. IC 87-2R had suggested that certain other provisions in Canada’s Income Tax Act would typically be applied before the transfer pricing rules, which is contrary to a new tax law ordering rule introduced in 2019. IC 87-2R had also suggested that a taxpayer’s existing transactions would only be subject to recharacterization or reconstruction by the CRA in “limited” and “exceptional” situations, which the CRA considers inconsistent with more recent guidance issued by the OECD. It remains to be seen whether the Cameco appeals decision, referred to earlier, will affect the CRA’s administrative position or lead to any changes in legislation.
Information Circular 71-17R5 (IC 71-17R5), Guidance on Competent Authority Assistance Under Canada's Tax Conventions, addresses the CRA’s administrative policy with respect to Mutual Agreement Procedures to resolve double taxation from transfer pricing and other tax disputes. IC 71-17R5 has been undergoing revisions, and a substantially revised draft “R6” is currently receiving input and comments from the taxpayer community.
Transfer Pricing Memorandum 3 (TPM-03), Downward transfer pricing adjustments under subsection 247(2), addressed the CRA’s administrative policy with respect to transfer pricing adjustments that reduce the income of a Canadian taxpayer. TPM-03 was moved from the CRA website in 2019 and marked as “under revision” but has not yet been replaced. The CRA announced at a Canadian Tax Foundation conference in March 2019 that TPM-03 is being updated to better clarify the CRA's positions on taxpayer requests, including when such files should be dealt with by the local tax services office or by the Canadian Competent Authority directorate.
Conclusion
Changes in Canadian transfer pricing rules may be coming soon, either in response to the Cameco decision or to the OECD’s Pillar One and Pillar Two proposals. In the interim, most taxpayers will likely preserve the status quo as changes in Canadian tax law do not typically have any retroactive effect.
