A recent transfer pricing case from the Tax Court of Canada (McKesson Canada Corporation v The Queen) establishes a broad interpretation of the "regular" (non-recharacterization) transfer pricing rule in the Income Tax Act and offers guidance on the adequacy of contemporaneous documentation. It is therefore an important case for multinationals doing business in Canada.
In McKesson, the Canadian taxpayer entered into a factoring arrangement with its Luxembourg parent in which it sold $460 million of trade receivables to the parent and entered into a five-year agreement to sell future receivables up to a $900 million cap. As is typical in factoring arrangements, the taxpayer sold its receivables at a discount to face. At issue was the quantum of the discount: the taxpayer used a formula that yielded a 2.206% discount in the year in question but Canada Revenue Agency (CRA) asserted an arm's length rate would have been 1.013%. (McKesson's traditional loss rate on receivables had been 0.043% before the factoring arrangement.) In a lengthy decision, Justice Boyle ruled against the taxpayer. An appeal has been filed.
One of the key issues in the case was the extent of adjustments that are permitted under the "regular" transfer pricing rule in s247(2)(a) and (c) of the Act (vs. s247(2)(b) and (d), which permit recharacterization of a taxpayer's transactions, but only in the absence of a bona fide non-tax purpose and on which CRA did not rely in the McKesson case). The Court held that these provisions permit adjustments to the quantum or nature of an amount used by a taxpayer to reflect what the quantum or nature would have been if the terms and conditions (including those not directly incorporating an amount) were arm's length. Applying this interpretation, the Court rejected the parties' approach of fixing certain elements of the discount for the full term of the agreement (although the agreement so provided) in favour of an amount consistent with a shorter term, floating rate. This is one of the grounds of the taxpayer's appeal.
The Court also delivered a warning to taxpayers that contemporaneous documentation that is a partisan attempt to justify the most advantageous transfer price, rather than reflecting a balanced assessment of the positions of the parties, should not meet the contemporaneous documentation standards in the Act and should not protect against penalties. We can expect that CRA will take this admonition seriously and taxpayers should carefully consider the adequacy of their transfer pricing documentation.