Rowing with only one ‘or’ in the water, as the interpretation of section 247(2) remains unclear

Volume No. 15-05

On June 12, the Federal Court of Appeal issued its decision on a motion brought by Cameco in an ongoing transfer pricing case.

The Federal Court of Appeal ordered the Crown to communicate to Cameco “its position as to the arm’s length price or prices at which Cameco and CEL ought to have purchased/sold uranium transacted between them during the 2003 taxation year or a formula which allows Cameco to identify this price or these prices”.  One would normally assume that in a transfer pricing dispute, the positions of CRA and the taxpayer on the price of the transaction in question would include an indication of the price each side believes is arm’s length.  The Cameco case shows that in the topsy-turvy world of Canadian transfer pricing, this cannot be assumed.

The CRA reassessed Cameco under paragraph 247(2)(a), paragraph 247(2)(b), Section 56(2), and by alleging the Cameco transaction structure was a “sham intended to conceal the fact that all income earning activities were performed in Canada”.

Section 247(2) allows the CRA to make an income or capital adjustment where paragraph (a) or paragraph (b) applies.  Paragraph (a) applies where the terms and conditions of the transaction or series are non-arm’s length.  Paragraph (b) applies where the transaction or series meets two conditions, namely: (i) the transaction or series would not have been entered into between persons dealing at arm’s length and (ii) the transaction or series “can reasonably be considered not to have been entered into primarily for bona fide purposes other than to obtain a tax benefit”

Where only paragraph (a) applies, the terms and conditions made or imposed, paragraph (c) then applies to re-price the transaction or series.  Where paragraph (b) applies, paragraph (d) then applies to replace the original transaction or series with a different transaction or series that would have been carried on between arm’s length parties, and then use the price from that different transaction or series to price the related-party transaction.

We could just describe the relationship between paragraphs (a) through (d) as follows:

If (a) implies (c) and (a) is true, then (c) is true

If (b) implies (d) and (b) is true, then (d) is true

If (b) implies (d) and both (a) and (b) are true, then (d) is true

But if a company or partnership were to follow the logic above, it may be out of step with the Tax Court of Canada in General Electric Canada and current CRA assessing practice as evidenced in a July 6 proposed reassessment of 2005 to 2010 taxation years of Silver Wheaton.  These interpretations of Section 247(2) suggest that both (a) and (b) can be true in a certain circumstance or that the distinction between them is blurred, opening what appears to be a route to replace a mispriced transaction with a different transaction as opposed to changing the price of the original transaction as follows:

If (b) implies (d), and either both (a) and (b) are true or (a) is the same as (b), then (a) implies (d)

Meeting the two-part test of paragraph 247(2)(b) is difficult, as is making the argument for an arm’s length price under 247(2)(c).  A logical bypass of paragraphs 247(2)(b) and (c) (or at least 247(2)(b)) is therefore a solution that CRA may find worthwhile to attempt.  This may be an attractive option when compared with a legislative amendment to include a rule with two ‘ors’ – (a) or (b) or ((a) and (b)) – that sets out the consequences to taxpayers of meeting these conditions.

Cameco is defending its position vigorously through uncertain territory.  In fairness, the CRA and the Tax Court are not alone in experiencing difficulty reasoning through the distinction between substituting an arm’s length price and substituting an arm’s length transaction when non-arm’s length conditions are found to have been used to determine taxable income.  This issue is the subject of the hotly debated and incomplete BEPS Actions 8, 9 and 10.

As we wait for the Cameco trial and decision, companies should treat Section 247(2) transfer pricing proposals of zero adjusted price, zero adjusted profit, and claims about what arm’s length parties would or would not do with professional skepticism, and consult a transfer pricing advisor.

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.