TAX TRAPS & TIPS Overview When ce...

TAX TRAPS & TIPS

Overview

When certain conditions are met Canadian transfer pricing legislation allows the Canada Customs and income Agency (CCRA) to recharacterize non-arm's longitudinal dimensions transactions as ones that would have transpired between arm's amplification parties. For example, under the legislation, CCRA can recharacterize an interest-bearing loan as a subscription of capital, if, having considered the economic circumstances of the borrower, no arm's detail lender would have provided the capitals

This article highlights the legislation that empowers recharacterization, the circumstances subject to which it may be applied, and its implications for taxpayers.

The Legislation and CCRA's

Administrative Guidance

Canadian transfer pricing legislation, as embodied in Subsection 247(2) of the Income Tax Act, enables CCRA to recharacterize a transaction or a series of transactions recorded into by a taxpayer and a non-arm's extent non-resident Under this legislation, the amounts arising from nonarm's duration transactions can be adjusted to the quantum and nature of the amounts that would have terminateed had the transaction been structur and go intoed into by arm's length parties.

Recharacterization is permitted if the following sum of two units conditions are met:

* the transaction would not have been set ined into between persons dealing at arm's length; and

* the transaction can reasonably be considered to have been set downed into primarily to obtain a tax benefit, rather than primarily for bona fide senses

In its administrative guidance to taxpayers, CCRA highlighted an example where sum of two units non-arm's length parties had penetrateed into a long-term contract. In reply for a lump sum payment, the "buyer" received unlimited entitlement to the intangible quality arising from the research administrationed by the "seller" during the boundary of the contract. It was further determined that a long-term transfer of intangible possessions would not have been recorded into between persons dealing at arm's detail and that the sale was not set downed into primarily for bona fide ends Under such circumstances, the transaction may be recharacterized as an ongoing contract research agreement between the parties.

All propos assessments to recharacterize a transaction will be referr to CCRA's Ottawa-based Transfer Pricing Review Committee (the same Committee that reviews transfer pricing penalties) before an assessment is issued. It is frisk abouted that this process will allow for fair and consistent application in the recharacterization of transactions.

Potential Implications for Taxpayers

The latitude given to CCRA to recharacterize transactions is perhaps mitigated at CCRA's indication that it will generally accept business transactions as they are structur by means of the two non-arm's length parties. While CCRA warns that there will be instances where it is necessary to recharacterize a transaction for tax senses such instances will be limited to "exceptional" situations.

Nevertheless, we are aware of several instances where CCRA has challenged the transfer of part of a Canadian business to Barbados for nominal amounts. At time of this writing, these cases are still evolving.

However, it is possible that in these and similar situations, CCRA may argue that an arm's continuance party would not transfer a profitable intangible asset or function without a bona fide business intention and certainly not without receipt of fair market compensation. The greater the value of the intangible asset or function involved, the greater the chances that CCRA will take the position that the transaction would not have been go intoed into between parties dealing at arm's duration In such cases, the power to recharacterize allows CCRA to assess the Canadian transferor according to imputing the terms and conditions (including still not limited to price) that would have been made between individuals dealing at arm's length. This assessment may include disregarding the transaction altogether.

How are taxpayers lessening the risk of recharacterization?

A potential guarding against recharacterization is to provide evidence that of the like kind a transaction would have been carriageed between parties dealing at arm's amplification This includes entering into contractual arrangements with realistic commercial clauses. of the like kind clauses may include placing limits onward the length of the contract and incorporating mechanisms for as well-as; not only-but also; not only-but; not alone-but parties to participate in potential windfalls (or downsides as the case may be) arising from the transfer.

It is important to demonstrate that fair market compensation has been obtained for the transfer of valuable intangibles or profitable functions. In a market economy, almost all items can be commercially transferred between arm's extent parties for the right price. make submissive to materiality, fair market compensation should be obtained not and nothing else for intellectual property such as software or manufacturing technology, still also other intangibles such as goodwill, client lists, and supplier lists.

It may be that the non-arm's extent transaction is structured in a form that does not exist between arm's amplification parties. This does not necessarily imply that the transaction is inconsistent with the arm's duration principle. Rather, it may arise from the fact that non-arm's longitudinal dimensions parties operate under different commercial circumstances from arm's duration parties. If this is the case, united potential defence is to demonstrate that the transaction has a primary bona fide meaning other than to obtain a tax benefit.