Transfer pricing draft information Circular (IC) 87-2R.

• Position: Revenue Canada IC 87-2R

April 22, 1999

On April 22, 1999, Tax Executives Institute submitted the following comments to Revenue Canada on a draft of a revised Information Circular (IC) 87-2R, relating to Canada's transfer pricing rules. TEI's comments took the form of a letter to Gary L. Zed, Director, Transfer Pricing and Competent Authority for Revenue Canada's International Tax Directorate. TEI's comments were prepared under the aegis of the Institute's Canadian Income Tax Committee, whose chair is John M. Allinotte of Dofasco, Inc. Contributing substantially to the development of TEI's comments were Vincent Alicandri of Ontario Hydro Services Corporation; Pierre M. Bocti of Hewlett-Packard (Canada) Ltd.; Roy M. Dulmage of Imperial Oil Ltd.; Marlene Gilbert of Nortel Networks; James A. McFall of Xerox Corporation; and David M. Penney of General Motors Canada Ltd.

In September 1997, the Government released draft legislation and a draft Information Circular (IC) 87-2R, International Transfer Pricing and Other International Transactions instituting new rules governing transfer pricing on transactions between Canadian taxpayers and other members of controlled groups of which the taxpayers are members. In response to an invitation from the Government, members of Tax Executives Institute, Inc. (TEI) met with representatives from Revenue Canada and the Department of Finance in November 1997 for informal consultations to provide their individual views on the draft legislation and the first draft of the IC. In January 1999, members of TEI again met with representatives of Revenue Canada to provide their preliminary views on the revised Draft IC.

TEI appreciates the opportunity afforded its members to meet with Government representatives for informal consultations, and we hope the Government finds the exchange of views on the legislation and draft IC to be productive. We are pleased to continue the dialogue by providing the following written comments in respect of the draft IC.

Background

Tax Executives Institute is the preeminent association of business tax executives in North America. The Institute's 5,000 professionals manage the tax affairs of the leading 2,800 companies in Canada and the United States and must contend daily with the planning and compliance aspects of Canada's business tax laws. Canadians make up 10 percent of TEI's membership, with our Canadian members belonging to chapters in Calgary, Montreal, Toronto, and Vancouver, which together make up one of our eight geographic regions. Our non-Canadian members (including those in Europe) work for companies with substantial activities in Canada. In sum, TEI's membership includes representatives from most major industries including manufacturing, distributing, wholesaling, and retailing; real estate; transportation; financial services; telecommunications; and natural resources (including timber and integrated oil companies). The comments set forth in this letter reflect the views of the Institute as a whole, but more particularly those of our Canadian constituency.

TEI is concerned with issues of tax policy and administration and is dedicated to working with government agencies in Ottawa (and Washington), as well as in the provinces (and the states), to reduce the costs and burdens of tax compliance and administration to our common benefit. We are convinced that the administration of the tax laws in accordance with the highest standards of professional competence and integrity, as well as an atmosphere of mutual trust and confidence between business and government, will promote the efficient and equitable operation of the tax system. In furtherance of this principle, TEI supports efforts to improve the tax laws and their administration at all levels of government.

Transfer Pricing Methods

A. Eliminate Implication of a Hierarchy Among Arm's Length Methods

Paragraph 2 of the draft IC states that the transfer-pricing rules in Canada's Income Tax Act (hereinafter "the Act") and Revenue Canada's administrative practices reflected in the IC are intended to adhere to guidelines promulgated by the Organisation for Economic Cooperation and Development (OECD). Indeed, paragraph 40 of the IC explicitly states that "section 247 [of the Act] is intended to reflect the arm's length principle which is articulated in the OECD Guidelines." In addition, paragraph 42 of the IC acknowledges that Canada's Income Tax Act neither mandates the use of a specific transfer-pricing method nor erects a hierarchy among transfer-pricing methodologies.

Notwithstanding those salutary statements, other paragraphs of the IC undermine or even conflict with the Act and the OECD's guidelines. TEI is especially concerned with the emphasis that the draft IC seemingly assigns to the hierarchy of transfer-pricing methods. Specifically, paragraph 51 states:

The most appropriate method in a given set of circumstances will be the one that provides the highest degree of comparability between transactions. Once a taxpayer selects a particular method and establishes comparability, the taxpayer is not required to make determinations under a lower-ranking method. The implication of the second sentence is that taxpayers must undertake an analysis of higher-ranking methods in order to justify the pricing method they select. Moreover, paragraph 152 reinforces this implication by stating that, for purposes of determining whether a taxpayer has made reasonable efforts sufficient to avoid penalties, the Department expects the taxpayer to document the "selection of a particular transfer pricing methodology, including an explanation of why the method selected is more appropriate than higher ranking methods." In addition, paragraph 154 explains by example that "the application of the residual profit split method would normally require an explanation of why higher ranked methods were not appropriate as well as details of the various comparable searches conducted." Finally, paragraph 160 states:

In general, the Department considers that the making of reasonable efforts to determine and use arm's length transfer prices or allocations requires the taxpayer to consider the application of a recommended method in accordance with the natural hierarchy of recommended methods." (Emphasis supplied). Hence, in the absence of a comparable uncontrolled price (CUP) for a particular transaction, property, or services, the IC seemingly requires taxpayers to perform multiple analyses based on the hierarchy of methods. Such a requirement is not only burdensome, but conflicts with the OECD's Guidelines on transfer pricing. Specifically, paragraphs 1.68 and 1.69 of the Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations...