Tax Tip[] BEPS

Is the CRA skipping dinner in the hope of getting its deserts? Digesting the “new” Canadian transfer pricing documentation standard

The CRA was recently asked “Will the CRA’s expectations of the “reasonable efforts” that a taxpayer must make to determine and use arm’s length transfer prices include the preparation of transfer pricing documentation that is consistent with the recommendations from the OECD in Action 13 of the BEPS initiative (i.e. Master File and Local File transfer pricing documentation)?

This is a reasonable question to ask in view of the years of work of the Canadian government delegates to the OECD Base Erosion and Profit Shifting Project (BEPS), and the endorsement of the final BEPS Project Action 13 Report by the Government of Canada in the latest federal budget.  Perhaps some were expecting harmonization with the new international norm, or more precise guidance on how to avoid penalties than can be found in the current six bullet points in paragraph 247(4)(a) of the Income Tax Act and a smattering of guidance.  The response suggests something different altogether.

Answer: “The CRA considers that BEPS Action Item 13 has been dealt with by the introduction of proposed section 233.8 of the Act relating to Country-by-Country Reporting. The “reasonable efforts” requirement is based on the legislation contained in section 247 of the Act, in particular the requirement to produce “contemporaneous documentation” in accordance with subsection 247(4). Proposed section 233.8 has no direct relation to section 247 and does not include a specific requirement to produce a “local file” or “master file”. As such, the CRA has not altered its criteria regarding whether a taxpayer has made reasonable efforts to determine and use arm’s length transfer prices.

Like a quietly disappointed restaurant patron wishing to be left alone to finish her mediocre dish, the CRA was in effect asked how it was enjoying its meal of the OECD’s new transfer pricing documentation guidelines.  Its response suggests local file and master file requirements were too much of an acquired taste, and the CRA has now sent those items back to the kitchen.  The diner’s overall response of “Fine…” derives only from the great pleasure the Agency may expect from a dessert of Country-by-Country reports, and from being able to claim the OECD confection has been adopted and was a good choice for Canada.

The prospect of the empty calories from the Country-by-Country data tables must be too thrilling to risk filling the stomach with the main course, as many other tax authorities are learning to do.  (CbC reports, like desserts, contain relatively little nutritional value, and are only intended to look at for risk assessment purposes, not to make a meal of for easy reassessment calculations.)  A feast of taxpayer data and a maintained state of uncertainty keeps the playing field tilted in favour of the CRA.

Many foreign tax authorities have adopted the Action 13 report as a whole as well as other new transfer pricing principles, in line with the intentions of their finance ministers.  Many tax administrations have also taken on board the updated OECD Transfer Pricing Guidelines.  These tax authorities will require the master file from foreign subsidiaries of Canadian-parented companies as part of their documentation requirement.  It will be burdensome for Canadian taxpayers to have to produce more documentation than is ostensibly needed (and risk creating more than one set of facts when double tax cases arise).  An opportunity to mitigate the median taxpayer’s burden has clearly been passed up.  The “new” documentation burden will fall disproportionately on Canadian companies with worldwide net sales under $ 1 billion (approximately €750M at today’s exchange rate) that do not have to file a CbC report, but also do not have extensive tax departments.  These mid-sized and smaller companies must now contend with the compliance cost of the CRA double standard.

If the CRA can ignore adding parts of the BEPS Project transfer pricing reports  to Canadian transfer pricing rules (despite those additions being endorsed by the most recent federal budget), one might ask what will be ignored next.  The CRA has stated publicly that it already takes similar positions to those set out in writing in the various BEPS transfer pricing final reports, making it seem the international guidance is of diminished value in Canadian transfer pricing matters.  Will the CRA adopt the OECD Guidelines as updated by the BEPS project, or stick with the 2010 version it finally recognized in October 2012?  The historical approach suggests it is appropriate to avoid setting down the CRA position in writing for some time.  Perhaps the CRA is waiting for the U.S. Department of the Treasury to walk away from the BEPS Project consensus after Donald Trump enters office, is hedging its bets in anticipation of several Tax Court decisions, or is really more interested in penalties and reassessments than encouraging compliance.

Taxpayers that have wondered “How good is good enough?” when it comes to interpreting the Canadian documentation requirement will continue to be offered a diet of junk food by the CRA and asked to keep guessing.  Unfortunately for taxpayers, the real rules are off the menu and appear only when requested directly by professional tax advisors.  Taxpayers owe the Canadian Tax Foundation a debt of gratitude for this revelation.

Canadians are known the world over for many great traits, but in taxation are increasingly known for picking the luke-warm bowl of porridge.  The made-in-Canada approach (or compromise) is also a favourite.  Companies will need to carefully consider how to approach this particular tepid bowl of Canadian porridge.


TRANSFER PRICING NEWSLETTER is provided as a free service to clients and friends of Cadesky Tax. Tax laws are complex and are subject to frequent change. Professional advice should always be sought before implementing a tax planning arrangement or taking an uncertain tax filing position. Cadesky Tax cannot accept any liability for the tax consequences that may result from acting based on the contents hereof.

A new way to do the splits: BEPS draft guidance falls short of enabling global formulary apportionment

This article also appears in INSIGHTS vol 3 no 7 published by Ruchelman PLLC (http://www.ruchelaw.com/newsletters/)

It takes considerable training and the right physical conditioning to successfully do the splits and avoid injury or embarrassment.  For those who view transfer pricing as a gymnastics sub-discipline, applying a profit split method is often an approach of last resort and is arguably as difficult to accomplish in a graceful manner as the gymnastic feat.  Since the BEPS (Base Erosion and Profit Shifting) Project began in 2013, a key focus the revision of the OECD guidance that multinational companies and tax authorities use to apportion income resulting from the joint commercialization of intangible assets within a multinational group.  The unwelcome, and potentially widespread, ex-post use of profit split methods as proxy for global formulary apportionment was viewed by corporate taxpayers and commentators with the same sense of dread as a surprise gymnastics skills test.

However, it would appear that companies can relax somewhat after the July 4 publication of the OECD Revised Guidance on Profit Splits discussion draft.  The discussion draft links other transfer pricing developments in the BEPS Project[1] to the guidance on the application of the transactional profit split method, but it does not propose to place an over-broad profit apportionment tool in the hands of tax authorities.

Like a gymnastic maneuver, successful application of the transactional profit split method requires a full understanding of risk – in this case economically significant risk incurred by the participants in the relevant business opportunity.  The transactional profit split method is one of five transfer pricing methodologies set out in Chapter II of the OECD Guidelines.  In cases where controlled taxpayers participate in highly integrated operations and contribute valuable intangible assets in respect of a joint business opportunity, the profit split method is used to split the profits or losses from the combined activity on an economically valid basis to approximate an arm’s length return to the respective contributors.

Not unlike the provisions of Treas. Reg. §1.482-6, the transactional profit split may be applied using either the more direct contribution analysis or the more indirect residual analysis (i.e., routine profits to the associated enterprises are determined first, and then deducted from the actual pooled profit to determine the residual profit to split).  The transactional profit split method can also be used in conjunction with a valuation method to estimate the value of an intangible asset transferred from one controlled taxpayer to another.

In contrast to the Treas. Reg. §1.482-6 method, the OECD Guidelines allow for the splitting of either anticipated or actual profit.  The discussion draft adapts the OECD Guidelines profit split by incorporating the changes to Section D.2.6.2 of Chapter VI that discuss how to reliably estimate anticipated profit from an intangible asset.  The draft properly points out that appropriate use of the transactional profit split method uses a profit split metric determined in advance of the knowledge of the actual profit to be divided between the two parties.  This serves as a reminder to companies of the evidentiary value of intercompany agreements – used in this instance to demonstrate taxpayer intent and to clearly set out the way in which a split of unanticipated profit will be calculated in the future.  The fact that an agreement is required to manage the uncertain outcome of a business activity where risk is shared, in and of itself, reinforces the appropriateness of a profit split method.

The use of the transactional profit split method based on the combined actual profits of the contributing parties is linked to the control exercised by those parties over the economically significant risks associated with the combined business.  The transactional profit split method may, therefore, not be appropriate in circumstances where the risks of the combined business are not separately or collectively controlled by the participants, or where each party does not have the financial capacity to assume its proportional share of the risk.  The evaluation of control over risk should be carried out annually, as actual profits are intended to be split each taxation year under the transactional profit split method.

This limiting control condition arises from the work completed by the BEPS Project, to date, on transfer pricing issues relating to intangible assets.  Interestingly, this new limitation on attribution of profit from intangible assets to only those entities exercising control over risk and possessing sufficient financial resources to mitigate risk circumscribes the authority of tax administrations to use the transactional profit split method in a formulary way, as was feared by many BEPS Project observers.

Some useful guidance appears in the discussion draft to differentiate a reliable profit split from a less graceful version.  Parties must “share the same economically significant risks”[2] associated with the combined business activity or “separately assume closely related risks”[3] associated with the same activity.

The term “economically significant risks” is explained in the revised Chapter I of the OECD Guidelines[4] as being those factors that cause the anticipated objectives or outcomes of the business activities for the contributing parties to vary to the greatest degree.  Strategic risks, marketplace risks, infrastructure risks, operational risks, financial risks, transactional risks, and hazard risks are suggested as the principal (though not the only) types of risk to consider.

There is, therefore, a less reliable profit split where

  • the economically significant risks have not been specified,
  • the nature of the contributions of the parties has not been accurately determined,
  • an evaluation of how those contributions influence profit outcomes has not been made,
  • the profits to be split have not been reliably identified, and
  • the basis for splitting the profits has not been reliably determined.

In certain cases, tax authorities (and sometimes companies) choose to skip the difficult work of comparability analysis or comparability adjustments, and apply the profit split method.  The discussion draft acknowledges a shortage of comparables may exist in practice, but it warns that a lack of comparables alone does not justify the use of the transactional profit split method.  Rather than stretching to apply the transactional profit split method, the discussion draft suggests that the use of a different method (inexact comparables) and well-supported comparability adjustments may result in a pricing outcome that better approximates an arm’s length result.

Similarly, the discussion draft sets out limitations, concerning integrated operations, unique and valuable contributions of intangible assets, and group synergies to the use of the transactional profit split method, in order to promote the responsible use of this transfer pricing method.  The mere appearance of integrated operations is stated as an insufficient condition for the application of the profit split method.  A careful functional analysis and an understanding of the company’s value chain is required to establish whether it is truly the case that the functions of company participants are so integrated that an intercompany transaction cannot be reliably delineated and perhaps priced using a more reliable methodology.

Finally, the discussion draft clarifies that treatment accorded to profits resulting from group synergies should differ from the treatment of profit resulting from the commercialization of intangible assets.  The benefits or cost savings connected with group synergies are termed “marginal system profits,” which should not be included in the “total system profits” to be divided using the transactional profit split method.

Room for disagreement exists with regard to the definition of a unique or valuable intangible asset, the degree to which a risk is economically significant, the importance of location savings, and the way market characteristics figure into a profit split analysis between a company based in a country with a developed economy and a related party with operations in a country with an emerging economy.  Nonetheless, the focus of the OECD guidance on intangible assets has been sharpened significantly, thereby reducing uncertainty for all.

[1] See, e.g., OECD, Aligning Transfer Pricing Outcomes with Value Creation, Actions 8-10 Final Reports, (OECD Publishing, Paris: 2015) (the “OECD Guidelines”).

[2] OECD, Public discussion draft, BEPS Actions 8 – 10, Revised Guidance on Profit Splits, (OECD Publishing, Paris: 2016), para. 16.

[3] Id.

[4] Supra note 1, Section D.1.2.1.1, pp. 25-28.


TRANSFER PRICING NEWSLETTER is provided as a free service to clients and friends of Cadesky Tax. Tax laws are complex and are subject to frequent change. Professional advice should always be sought before implementing a tax planning arrangement or taking an uncertain tax filing position. Cadesky Tax cannot accept any liability for the tax consequences that may result from acting based on the contents hereof.

Canadian transfer pricing rules – scattered from far and wide

The recent March 22 budget announced an update of the transfer pricing guidance used by the CRA.  The main change was the adoption of the revised OECD Transfer Pricing Guidelines, last amended in October 2015 as a result of the OECD/G20 BEPS Project.  While this guidance does not have the force of law, it is used by the CRA in transfer pricing audits as well as selectively by Canadian courts.

This announcement itself is noteworthy only in its timing, given CRA has deviated somewhat from the international consensus on the implementation of the BEPS Project results.  More notable is that Canadian transfer pricing guidance is now scattered across 22 documents – add a few more for large companies required to file a Country-by-Country report.  This count does not include the law or transfer pricing decisions from the courts, which are critical to consider.

The result will be awkward and time-consuming reading until the OECD Guidelines are properly reissued in the next few years after the conclusion of further work.

In the long-run, taxpayers and their advisors should ideally be able to reference two or three documents, in addition to relevant jurisprudence.  We’ll update you once we get there.


TRANSFER PRICING NEWSLETTER is provided as a free service to clients and friends of Cadesky Tax. Tax laws are complex and are subject to frequent change. Professional advice should always be sought before implementing a tax planning arrangement or taking an uncertain tax filing position. Cadesky Tax cannot accept any liability for the tax consequences that may result from acting based on the contents hereof.

Yes, Virginia, there is a Santa Claus – BEPS Action 11 is still searching for quantification of corporate income tax lost to BEPS

Of all the actions in the G20 and OECD Base Erosion and Profit Shifting (BEPS) Project Action Plan, Action 11 always seemed somewhat out of sequence.  Action 11 is preceded by ten other action items that propose changes to the international corporate tax system (many of these changes have to do with how to calculate a document a transfer price) that will lead to the payment by companies of their “fair share” of corporate tax.  Action 11 proposes to measure how far the current system leaves the world’s governments short of their “fair share” owing not only to incorrect transfer pricing, but also to other forms of base erosion and profit shifting.  Businesses have been asked thus far by the G20 to believe in Santa Claus – to accept that there are large problems with the transfer pricing regime, so that the OECD can get on with the urgent work of fixing things.

On April 15, the OECD released its draft Improving the Analysis of BEPS, making clear that the question of how to measure the loss of tax revenue from BEPS-afflicted transfer pricing activity is still very much unanswered.

Estimates of the loss from BEPS vary widely.  More fundamentally, there is no consensus yet on whether it is the lost tax revenue or the lost economic output that should be measured.  Looked at from a lost tax revenue standpoint, the most reliable estimates with which I am familiar are USD $22 billion (NBER) and USD $70 billion (MCSI).  Though not insignificant in nominal terms, these loss amounts are small when compared with world tax revenue or national income.

It becomes clear however that the political reality of our time will cause economists to wait for tax authorities to gather corporate tax return data to use to estimate the extent of lost tax revenue from BEPS.  The Action 11 draft talks about what should be measured using existing micro-level or firm-level data collected in tax returns.  Tax authorities will get a more thorough data set to work with from multinationals with sales greater than €750 million thanks to the Action 13 country-by-country reporting requirement expected to come into force in 2017 in many countries.  This will influence roughly 1700 US taxpayers, in addition to others. 

Given the ambitious timetable and state of progress of the OECD’s reforms, companies could soon find themselves in a position of having to comply with new transfer pricing legislation without seeing the proof that there is a compelling public finance rationale for this legislation.  Perhaps companies cannot be blamed this time for having been “affected by the skepticism of a skeptical age”, just like the young friends of Virginia O’Hanlon in 1897.


THE NON-ARM’S LENGTH NEWS is provided as a free service to clients and friends of Cadesky Tax. Tax laws are complex and are subject to frequent change. Professional advice should always be sought before implementing a tax planning arrangement or taking an uncertain tax filing position. Cadesky Tax cannot accept any liability for the tax consequences that may result from acting based on the contents hereof.