Canada Revenue Agency (CRA) Releases their 9^th Annual Report on the Mutual Agreement Procedure (MAP) Program.

The 9^th annual MAP report covers the fiscal year ending March 31, 2012. The highlights of the report include:

• 87 negotiable MAP cases accepted (the CRA divides MAP cases into negotiable, which are bilateral cases, and non-negotiable cases; which do not require negotiations with other tax administrations),

• 97 negotiable MAP cases completed, and;

• The average time to complete Canadian-initiated cases was 31.46 months, which was a slight decrease from the prior year but well above the target of 24 months. The average time to complete Foreign-initiated negotiable MAP cases was 20 months, which was below the target.

The top three transfer pricing methods applied on completed negotiable MAP cases has been consistent since the annual report was released: (i) Not applicable method, (ii) the cost plus method, and (iii) the transactional net margin method using the operating margin.

The report did not comment on the cases that have proceeded to arbitration.

The Organisation for Economic Co-operation and Development (OECD) Model Tax Convention on Income and on Capital recommends that bilateral tax conventions include a MAP article as a form of dispute resolution mechanism. This dispute resolution mechanism addresses, amongst other things, cases of double tax arising from a transfer pricing reassessment. In Canada, the Minister of National Revenue authorizes senior officials within the CRA to endeavor on his behalf to resolve a tax dispute under a tax convention. These senior officials are referred to as the Competent Authority.

The Latest on Glaxo

The Canadian transfer pricing community’s anxious wait on the first transfer pricing decision from the Supreme Court of Canada (SCC) arrived on October 18, 2012. The SCC denied the appeal from the Minister of National Revenue (MNR) and denied the cross appeal from GlaxoSmitheKline Inc. (Glaxo Canada).  There was no final resolution to this nearly 20 year dispute and the SCC sent the parties back to the Tax Court of Canada (TCC) allowing for new evidence to be provided. That is the bad news. The good news: there is constructive guidance  from this SCC jurisprudence, including:

• Business and economic factors that an arm’s length party would consider in determining a transaction price are also to be considered by non-arm’s length parties in determining a transaction price. The SCC rejected the MNR’s position of viewing one transaction in isolation without considering business factors such as the license agreement which provided Glaxo its rights to the product in question.

• There should be no adjustment to a transfer price when it falls within a reasonable range. If the price is not in a reasonable range, then some point in the range should be selected based on the specific factors of that transaction. This point may be a statistical measure such as the average, median, or other.

• The scope of the parties’ functions and their risks should be consistent with the transfer pricing policy. In the case of Glaxo, the position of the MNR would result in an increase of income to Glaxo Canada of $51 million. Glaxo Canada has the scope and responsibility of a secondary manufacturer and marketer. Glaxo Group Ltd. has the scope and responsibility of an owner of the intellectual property, and also a provider of other benefits to Glaxo Canada.

Glaxo Canada’s Withholding Tax Puzzle

The MNR lost their key position, being that the License Agreement for Zantac and the Supply Agreement of the raw ingredient ranitidine can be tested and priced separately. This is the “transaction-by-transaction” position. The SCC’s rationale for rejecting the MNR’s position is based on their understanding that the Supply Agreement included a bundle of rights and benefits above that granted to Glaxo Canada from the License Agreement. That is, the purchase price of ranitidine is for both the tangible product as well as intangibles. This is where the withholding tax issue now arises. The intangible portion of the purchase price is typically associated to be a royalty that has Part XIII withholding tax implications. The SCC simply raised this issue. Because the MNR lost their key position, it would be safe to assume this withholding tax exposure for Glaxo-Canada will not be out-of-mind for the MNR.

Other Canadian companies that follow a transactional net margin method for transfer pricing and sell an imported product that commands a premium price in the Canadian market may have similar withholding tax exposure.

It has been widely predicted in the Canadian transfer pricing community that Glaxo and the MNR will likely settle and avoid any future court hearings. For additional detail on the facts and ramifications behind this landmark Canadian transfer pricing case, click here. 

CRA Releases Two New Transfer Pricing Memorandums (TPMs)

With almost four years since TPM-12 was released, TPM-13 and TPM-14 (with the issue date of October 30, 2012, and October 31, 2012, respectively) were released on November 22, 2012. TPM-13 is the second update since 2003 and addresses the referrals to the Transfer Pricing Review Committee (TPRC). TPM-13 clarifies the following procedures:

1. The procedure for the imposition of penalties;
2. The procedure for the re-characterization of transactions; and
3. The procedure in determining whether an arrangement is a Qualified Cost Contribution Arrangement (QCCA).

Updates of interest in TPM-13 include:

• Formalizing the provision of the TPRC proposal letter and the auditor’s draft penalty referral report to the taxpayer. The taxpayer will be provided a reasonable period of time to respond and address any factual omissions or discrepancies with the auditor’s report; and
• The TPRC will determine whether an arrangement is a QCCA for transfer pricing adjustments exceeding the threshold for penalty consideration (the lesser of 10% of gross revenue and $5 million).

TPM-14 addresses the CRA’s position and guidance with respect to recent changes made in the 2010 version of the Organisation for Economic Co-operation and Development (OECD) Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (the OECD Guidelines). Specifically:

• The CRA yielded from the “hierarchy” method to the “best” method in selecting the appropriate transfer pricing method. The “best” will be based on the quality of the data that is available.  In cases where each method can be applied in an equally reliable manner, the CRA prefers the “hierarchy” method;
• The CRA endorsed the OECD 9-step comparability analysis for finding reliable comparable data, with a caveat that taxpayers used reasonable efforts in performing the analysis; and
• The CRA has referenced and endorsed other additions of the OECD Guidelines including the transactional profit method and the transfer pricing aspects of business restructuring.