Evolution of Transfer Pricing Disputes PPTS/3...2017 IFA International Tax Conference Transfer...

Tuesday April 25 & Wednesday April 26 Metro Toronto Convention Centre

Evolution of Transfer Pricing Disputes

Phil FortierDeloitte

2017 IFA International Tax Conference

Transfer Pricing Audits and Treaty-Based Resolutions – Key Operational and Administrative Developments – 1997 – 2010

● Creation of the International Tax Directorate● Transfer pricing and competent authority, exchange of

information● Thinly staffed, initially no designated TSO resources

2

Late 1980’s



● US 482 Regulations bring attention to transfer pricing● Resources allocated to international tax gradually

increased ● Staffing of additional positions in Headquarters and

the Tax Services Offices (“TSOs”)● International tax advisors added to provide support to

the TSOs on files● Use of Form T106 in risk assessment/audit selection

3

Early to mid 1990’s



● The February 1997 Federal Budget announced that Canada will amend the transfer pricing provisions in the ITA

● Draft Section 247 released in September 1997● Submissions received and considered● Notice of Ways and Means Motion in December 1997● Royal Assent in June 1998 ● Legislation generally in effect for taxation years

beginning after 1997 (Penalties after 1998)

4

New Transfer Pricing Legislation in Canada



● Arm’s length rather than reasonable amount● Transfer pricing penalty ● Contemporaneous documentation● Recharacterization provision ● Downward adjustments permitted

5

Important changes in Section 247



● Increase in resources allocated to the CCRA in connection with the new transfer pricing legislation.

● Expansion of the Transfer Pricing and Competent Authority Division

● Outreach to the TSOs and the public on Section 247 and IC87-2R

● By 2000 the international audit program had grown to a TSO headcount of approximately 115 supported by 30 in the headquarters Transfer Pricing and Competent Authority Division.

6

1998 – 2000



● Information Circular 87-2R released in September 1999

● Application of the Section 247 transfer pricing rules● Link to the OECD transfer pricing guidelines● Methodologies● Intangibles, Services● Secret comparables● Penalty application and the Transfer Pricing Review

Committee

7

IC87-2R - Guidance from Revenue Canada



● Creation of separate International Tax Operations and Competent Authority Services Divisions in the ITD

● Field Advisory Services teams established and later geographically focused to provide support to the TSOs

● Additional training materials developed and delivered● Additional auditors and economists in HQ hired, trained

and deployed to support the TSOs and the APA and MAP programs

● Expanded Legal Services support for TSO cases● Use of information gathering powers by TSOs encouraged

and expanded S231.2, S231.6, EoI● Increasing sophistication of audits ● Moving from largely cross border services audits to

tangibles, intangibles and financing.

8

Early 2000’s



● Continued outreach activities by both the International Tax Division and Competent Authority Services Division

● Increased interest in Advance Pricing Arrangements in response to the new transfer pricing legislation.

● IC94-4R issued in 2001 detailing APA procedures● In 2002, the CRA’s APA Program Development

Strategy was released

9

Early 2000’s



● Cases under the “new” section 247 proceeding to reassessment

● Transfer Pricing Review Committee (“TPRC”) established

● Five cases referred to the TPRC in the first year● First transfer pricing penalty assessed● Transfer Pricing Memorandum series started to

supplement guidance in IC87-2R● First CCRA APA Program Report released covering

up to 2003.

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2003/2004



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APA Program Report



● Additional funding in the Federal Budget to target aggressive tax planning

“Increase audit and enforcement resources of the CRA by $30 million annually to discourage aggressive tax planning through international transactions and, in particular, the use of tax havens.”

“These resources will be used to increase audit and compliance capacity with respect to cross-border and international transactions, using a risk-based approach.”

● 100 additional international tax auditors● Risk assessment gains more focus● CRA part of multi-country working groups on risk

assessment● Move to supplement “judgement” with algorithms in

selecting audits

12

2005



● IC71-17R5 released containing revised guidance on obtaining competent authority assistance to resolve double taxation

● Competent Authority Services Division reorganized its four MAP units by specialization.

● Two MAP/APA Sections, a MAP-Technical Cases section and an Economic Services section

● Green light, yellow light, red light trial to rate APAs.

● “First Step” meetings with taxpayers offered to discuss the suitability of an APA.

13

2005



o Numbers of penalty referrals: 55

o Numbers of penalty applied: 32 58%

o Numbers of 247(2)(b) referrals: 13

o Recommendation to pursue: 12

o Reassessed: 0

14

Transfer Pricing Penalty Statistics May 2005



● Taxpayers and tax administrators continue gaining experience with the concept of “reason efforts” as it applies to transfer pricing documentation

● TPM-09 Reasonable efforts under section 247 of the Income Tax Act is released

15

2006



● Additional resources in the 2007 Federal Budget“The CRA will be provided with additional resources to strengthen the enforcement of Canada’s tax system in relation to foreign income and cross-border transactions. Particular emphasis will be placed on transfer pricing transactions and complex international tax avoidance cases.”

● International audit program grows to approximately 465 International auditors supported by 60 auditors and economists in the International Tax Division in headquarters

● Approximately 50 analysts and economists in Competent Authority Services Division responsible for APA, MAP, EoI

16

2007



● Creation of the new International and Large Business Directorate

● International working cooperatively with Aggressive Tax Planning and Large Files

● Increased emphasis on using S 231.2 and S 231.6 requirements and EoI

● Improved risk assessment tools being developed

17

2007



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Transfer Pricing Penalty Statistics March 2007o Numbers of penalty referrals: 92




o Reassessed: 2



● Period of consolidation● New resources received from the 2005 and 2007

Federal Budgets are integrated● Integration of International Tax, Aggressive Tax

Planning and Large Files continues● APA program begins to see more renewals● New guidance released

TPM 11 Advance Pricing Arrangement Rollbacks

TPM 12 Accelerated Competent Authority Procedure

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2008 - 2009



o Numbers of penalty referrals: 162




o Reassessed: 6

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Transfer Pricing Penalty Statistics December 2008



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APA Program Statistics March 2008

Evolution of Transfer Pricing DisputesTransfer Pricing Audits and Treaty-Based Resolutions – Key Operational and Administrative Developments – 2010 - 2017 (CRA Perspective)

Alexandra MacLean Canada Revenue Agency

23

Operational Changes April 1, 2016, the Compliance Programs Branch

assumed a two branch structure consisting of the International, Large Business and Investigations Branch (ILBIB) and the Domestic Compliance Programs Branch (DCPB).

April 11, 2016, Minister of National Revenue announced the creation of an independent advisory committee to combat offshore tax evasion and aggressive tax avoidance: Offshore Compliance Advisory Committee (OCAC).

• Comprised of independent experts with significant legal, judicial and tax administration experience.

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Administrative Changes

December 5, 2016, the Minister received the OCAC’s report on the Voluntary Disclosures Program (VDP). One of the recommendations proposed excluding transfer pricing penalties from VDP. (Approximately $194 million in transfer pricing penalties were applied in 2015-2016 fiscal.)

CRA is currently considering the OCAC recommendations.

October 2016 report of the Standing Committee on Finance - The Canada Revenue Agency, Tax Avoidance and Tax Evasion: Recommended Actions.

TPRC Statistics

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TOTAL TPRC REFERRALSPenalty Referrals ‐ 247(3) 600 89%Re‐Characterization ‐ 247(2)(b) 75 11%Total Cases Referred 675 100%

247(3) PENALTY REFERRALSPenalty Recommended 254 42%Penalty not Recommended 346 58%Total 247(3) Cases Referred 600 100%

247(2)(b) Re‐characterizationsDenied / abandoned 50 67%Assessed 19 25%Ongoing 6 8%Total Cases Referred 75 100%

TPRC Executive SummarySince Inception

(Note: “since inception” - TPRC statistics recorded since July 2003)

TPRC Statistics

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TOTAL TPRC REFERRALSPenalty Referrals ‐ 247(3) 58 91%Re‐Characterization ‐ 247(2)(b) 6 9%Total Cases Referred 64 100%

247(3) PENALTY REFERRALSPenalty Recommended 12 21%Penalty not Recommended 46 79%Total 247(3) Cases Referred 58 100%

247(2)(b) Re‐characterizationsDenied / abandoned 2 33.3%Assessed 2 33.3%Ongoing 2 33.3%Total Cases Referred 6 100%

TPRC Executive Summary 2016-2017 Fiscal Year

Operational Changes – Audit Teams Integrated Large Business Audit teams:

• Historically, domestic, aggressive tax planning and international were in different sections.

• Integrated approach to large business compliance, effective April 1, 2016.

• Now, senior auditors from domestic, aggressive tax planning and international report to an International and Large Business Case Manager (ILBCM).

• ILBCM manages taxpayer relations.

Dedicated Specialty teams:• Self-generated workload;• Mandatory workload; and• Omnibus funding projects (e.g., TFSA).

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Case Development ITD involvement relatively unchanged since 2007

• Field Advisory Services renamed to International Advisory Services Sections.

• Geographical workload responsibilities. • Regional International Tax Advisors, auditors,

economists, FAPI specialists. In 2009, pilot project with tax law services,

Department of Justice to have legal counsel in the field. Pilot was successful and lawyers are still in place in each region. Information gathering at audit - we have always

encouraged the use of compliance orders, requirements, EOI.

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Performance Approximately 2,500 employees involved in international,

large business and aggressive tax planning audit areas.

2015-2016:

Completed 15,864 international and large business audits, including 13,395 aggressive tax planning audits and 185 offshore audits. Change rate of 77% (target 75%). Over $7.9 billion in fiscal impact. $553 million refunded during 2015-2016 through the

resolution of double taxation issues with Canada's treaty partner countries (amount had been included in program results for prior years). 29

Risk Assessment Approach to Large Business Compliance (ALBC):

• Phased in over five-year period, commenced in 2010-11.

• Examines taxpayer’s compliance risk.• Face-to-face meetings with the highest risk

taxpayers.• Responsible corporate tax management

behaviour and practices, reduce behavioural risk, enhance voluntary compliance.

Recent enhancements to risk assessment systems –risk-based approach rather than coverage-based. Identify risk indicators within the taxpayer population. Country-by-country reporting will be integrated into

our risk assessment systems.30

Risk Assessment, continued The risk indicators identified through our

integrated risk assessment system (IRAS) are given to ILBCMs, auditors and industry specialist services for further analysis of inherent and behavioural risk factors.

Risk profile developed for the large business population and the taxpayers within that population. Highest risk cases in work plans:

• Highest risk = full compliance audit• Medium risk = full compliance or issue-based audit• Low risk = compliance-assurance review

Regional and national calibration. 31

Exchange of Information (EOI)Types of information that can be obtained:

Automatic EOI – broad-based automatic exchanges with our treaty partners – e.g., information regarding non-residents as it relates to their income and activities in Canada; Country-by-Country Reporting; Common Reporting Standard; Intergovernmental Agreement (IGA). EOI on request (specific) – wide variety of

“foreseeably relevant” information – e.g., contracts, requests for banking information, contemporaneous documentation. Spontaneous EOI – information of interest to/from a

treaty partner and exchange of tax rulings/unilateral APAs.

32

Exchange of Information (EOI), continued

EOI can obtain information from foreign countries by using:• Tax Treaties (93);• Tax Information Exchange Agreements (22);

and• Convention on Mutual Administrative

Assistance in Tax Matters (MAC), which adds over 10 countries to CRA’s EOI network.

33

Mutual Agreement Procedure (MAP) Where a person considers that the actions of one

or both countries which are party to a treaty result, or will result, in double taxation, the person may request competent authority assistance under the MAP article of a treaty. Most common disputes:

• Transfer pricing;• Withholding tax rates;• Residency;• Determination of a permanent establishment

(PE); and• Attribution of income to PEs.

34

Mutual Agreement Procedure (MAP), continued

35

In conjunction with OECD reporting standards, CASD will be changing its reporting period for MAP statistics to be aligned with a calendar (vs March 31) year end, and also adopt OECD milestone definitions for reporting purposes.

MAP Policy Developments IC 71-17, issued in 2005, is currently being

revised. It will address changes to the Canada-U.S. Income Tax Convention covering:

• Arbitration;• Use of the authorised OECD approach (AOA) when

determining business profits under Article VII;• Treatment of limited liability companies (LLC’s); and• Revisions to policies and procedures for 13(8)

requests. It will also provide additional clarifications with

respect to taxpayers maintaining their treaty rights; roles and responsibilities of the taxpayer and competent authority; and, update policies and procedures. 36

Advance Pricing Arrangements (APA) Taxpayer may approach the CRA (CASD) to enter into a

bilateral or multilateral APA agreement with another tax administration(s) covering a taxpayer’s specified international transactions with its related party(ies). Where a taxpayer accepts the terms of an APA

agreement reached by the CRA with another tax administration(s) and files its returns in accordance with the terms of the APA, they will not be subject to transfer pricing penalties. For the CRA, the program has become an important

compliance tool. The APA program is mature. As APAs come up for

renewal, in many cases, where facts and circumstances have not changed, it is possible to renew existing agreements in an efficient manner.

37

APA Program Application and Inventory Statistics

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Advance Pricing Arrangements (APA), continued The APA program benefits both taxpayers and

the CRA:• Allows taxpayers to avoid the uncertainty

associated with an audit.• Allows for transparent exchange of ideas and

information with the goal of seeking an agreement acceptable to all participating parties.

• Where APA agreements are reached, taxpayers, the CRA and other tax administrations save time and money.

39

APA Policy Developments Current version of IC94-4, issued in 2001, is also

being revised, and will contain updated information and guidance on:• Pre-filing process;• Criteria used when accepting requests;• Criteria used when rejecting requests;• Roles and responsibilities of taxpayers;• APAs and the arbitration process for the

Canada-U.S. Treaty; and• Other changes in policies and procedures

which have been incorporated since 2001.

40

Thank you



John J. TobinTorys LLP

Toronto


Evolution in the Courts

● Evolving Transfer Price Case Lawo Life Before Glaxoo Glaxo and beyond

● Our learning from the Courts

● Role of Courts: Judicial Review

● Fights about Information: Demands, Privilege and Lawyers Accounts and Records

● 247(2)(b)

● Emerging Disputes

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Introduction



Indalex [1988] 1 C.T.C. 60 (FCA)

Irving Oil [1988] 1. C.T.C. 263

Spur Oil Ltd. [1981] C.T.C. 336 (FCA)

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There was life before Glaxo



GlaxoSmithKline Inc. v. R. (2012), 2012 SCC 52

General Electric Capital Canada Inc. v. R., [2011] 2 C.T.C. 126 (FCA)

Alberta Printed Circuits Ltd. v. R., 2011 TCC 232

McKesson Canada v. R. 2013 CarswellNat 4830

Marzen Artistic Aluminum Ltd. v. R. (2016), 2016 FCA 34

45

Glaxo and beyond



● Common in TP cases for Crown to allege sham

● Early cases rejected sham in TP despite artificiality of transaction citing Snook – is Sham dead or alive today?

● Would s. 247(2)(b) impact on Spur or Irving Oil if decided today?

● Apply s. 247(2)(b) to transactions without a bona fide business purpose?

46

Learning from the Courts: Transactions that are artificial (having no business purpose) are not Shams



● The Guidelines contain commentary and methodology pertaining to the issue of transfer pricing. However, the 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 s. 69(2) rather than any particular methodology or commentary set out in the Guidelines (Glaxo, p. 20)

● Act does not mandate method, but OECD does. Prefer the one with highest degree of comparability between transactions. (Alberta Printed Circuits, p. 169, 170)

● Where there are doubts about reliability, taxpayer should confirm the results by applying another method to find consistency (Alberta Printed Circuits, p. 176, 177)

47

Learning from the Courts: OECD Guidelines



● A judge is to take into account all transactions, characteristics and circumstances that are relevant (including economically relevant) in determining whether the terms and conditions of the transactions or series in question differ from the terms and conditions to which arm’s length parties would have agreed (Glaxo, p. 42, Mckesson, p. 120)

● All relevant factors that a reasonable business person in the Appellant’s shoes would consider (Alberta Printed Circuits)

● All relevant factors include those that arise from the non-arm’s length relationship or otherwise (GE Capital, p. 54)

● Act calls for the elimination of all the distortions that arise in any given transaction between related parties (Marzen, FCA, p. 48)

● Must apply TP to each separate entity – not an amalgam (Marzen)

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Learning from the Courts: Factors in Comparability



● Reasonable steps must be taken to test the validity of the suggested external CUP by both the party asserting its applicability and the party disputing it (Alberta Printed Circuits, p. 192)

● Require an attempt to obtain comparables even if difficult and make every attempt to distinguish between them must be made (Alberta Printed Circuits, p. 209)

49

Learning from the Courts: CUP Method



As long as a transfer price is within what the court determines is a reasonable range, the requirements of the section should be satisfied. If it is not, the court might select the point within a range it considers reasonable in the circumstances based on an average, median, mode, or other appropriate statistical measure, having regards to the evidence that the court found to be relevant. I repeat, for emphasis, that it is highly unlikely that any comparisons will yield identical circumstances and the Tax Court judge will be required to exercise his best informed judgment in establishing a satisfactory arm’s length price. (Glaxo, p. 61)

50

Learning from the Courts: Ranges



● Each Taxation Year for each taxpayer is a different cause of action

● No abuse for Crown to argue different position in later years

● Tax Court decision does not preclude future audit of different years or different group members (GE Capital)

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Learning from the Courts: No Finality



● CA Process is subject to judicial review if court in its supervisory role shows appropriate defence to the role of the Minister and her prerogative over foreign affairs (Khadr)

● Standard of review is to “endeavor” to resolve by mutual agreement

● Conclusion must be within a range of possible outcomes of MAP Process (CGI, para 51)

52

Role of Courts: Judicial Review



● 231.1, 231.2, 231.7

● Requests made for lawyer’s documents 231.1 231.7o Lawyers and notaries are imbued with privilegeo Lawyers accounts can be privileged (Chambres des notaries,

Federation of Law Societies)

● Demands against non-lawyers may still be made (privilege can be adjudicated separately). (Revcon Oilfield, FCA p. 9)

● 231.6 - Information from non-residents can be compelled if relevant and reasonable information required – low standard to establish (SoftMoc)

53

Fights about Information: Demands, Privilege and Lawyers Accounts and Records



● Accountants working papers – issues listo BP Canada (FCA)

● The wounding of “common interest privilege”o Iggillis Holdings Inc.

54

Fights about Information: Demands, Privilege and Lawyers Accounts and Records



● Cameco - final argument in 2nd half of 2017 in Tax Court

● When should s. 247(2)(b) be applied?o McKesson?

● Where Minister alleges no fee would be payable? (GE Capital)

● Marzen: “empty shell with no personnel, no assets and no risk”?

● Interco group transactions – precisely because no one would do same transaction

● In lieu of sham?

55

Section 247(2)(b)



● Accounting risk assessment requires disclosure be made by public companies

o Silver Wheaton - appeal commenced January, 2015 2005 – 2010 – $353 million 2001 – 2013 – $310 million

o Spinmaster – settlement for $15 million, no penaltyo Lululemon – reach 2017 APA

● 50% tax payment for large corporations creates large financial risk also requiring disclosure

● Size is often material

56

Emerging Disputes: Cases Being Disclosed in Public Documents



H. David RosenbloomWashington, DC


A U.S. Perspective: Transfer Pricing Litigation, Administrative Developments and Arbitration

A. The Transfer Pricing Story in the United States Is Quite Different From the Story in Other Jurisdictions.

B. Controversies That Reach U.S. Courts Are for the Most Part Concerned With Issues Pertaining to Cost-Sharing Agreements.

58

I. Significant Court Decisions



C. The Principal Cost-Sharing Issues Are (a) the Amount of the Required “Buy-In” Payment for Intangibles That Will Place All Parties to a CSA on the Same Footing and (b) Whether Stock-Based Compensation Is a Cost That Must Be Shared.

D. A Major Decision of the U.S. Tax Court in Amazon on March 23, 2017 (148 T.C. No. 8) Deals Directly With the First Issue and Notes That the Second Issue Turns on the Pending Government Appeal of Its Loss in Altera Corp. (145 T.C. 91 (2015)).

E. Amazon Follows Veritas Software Corp. (133 T.C. 297 (2009)) in Rejecting a Perpetual or Indeterminate Useful Life for Bought in Intangibles.

59



F. Altera Followed Xilinx Corp. (125 T.C. 37 (2005)) in Holding That Stock-Based Compensation Is Not a Cost That Must Be Shared.

G. There Are, From Time to Time, Decisions With Respect to Traditional Transfer Pricing Issues (e.g., Medtronic (11 T.C.M (CCH) 1515 (2016)), But These Seem Less Significant in Both Dollar and Legal Terms.

60



A. On January 31, 2017 the Internal Revenue Service Launched 13 “Compliance Campaigns,” Two of Which Relate Directly to Transfer Pricing.

B. Campaign No. 5 Deals With Related-Party Transactions Entered Into by Mid-Market Taxpayers. The Campaign Is Not Limited to Transfer Pricing, But That is One of Its Focus Areas.

C. Campaign No. 13 Involves an Examination of Returns Earned by U.S. Distributors of Tangible Goods Imported From Foreign Related Parties for Consistency With the Arm’s-Length Standard.

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II. Administrative Developments



D. Campaign No. 13 Seems To Be Limited to Transfer Pricing Matters.

E. It Is Far From Clear Whether These Campaigns Have Major Practical Significance. Much More Significant for Tax Administration in the United States Is Congress’s Systematic Underfunding of the Tax Authority.

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A. Adoption of Mandatory Arbitration in the Fifth Protocol Has Significantly Changed Both the Process and the Timetable for Resolving Cross-Border Transfer Pricing Disputes.

B. The Prospect of Arbitration Is Now Incorporated in Every Mutual Agreement Procedure From the Outset.

C. It Is Very Difficult To Secure Reliable Information Regarding How Many Arbitrations There Have Been and the Precise Issues in Question, But It Does Appear That Arbitration Has Had a Salutary Effect on the Dispute-Resolution Process, at Minimum Expense and With No Negative Externalities.

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III. Developments in Regard to the U.S.-Canada Income Tax Convention

Evolution of Transfer Pricing Disputes PPTS/3...2017 IFA International Tax Conference Transfer...

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