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Transfer pricing taxation : Canadian perspective and Japanese perspective Nakayama, Kiyoshi 1987

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TRANSFER PRICING TAXATION CANADIAN PERSPECTIVE AND JAPANESE PERSPECTIVE  by  KIYOSHI NAKAYAMA LL.B., KOBE UNIVERSITY, 1981  A THESIS SUBMITTED IN PARTIAL FULFILLMENT OF THE REQUIREMENTS FOR THE DEGREE OF MASTER OF LAWS  in  THE FACULTY OF GRADUATE STUDIES ( F a c u l t y o f Law)  We accept t h i s t h e s i s as conforming t o the r e q u i r e d  standards  THE UNIVERSITY OF BRITISH COLUMBIA MAY ©  1987  K i y o s h i Nakayama, 1987  In presenting degree  this  at the  thesis  in  partial fulfilment  of  University of  British Columbia,  I agree  freely available for reference copying  of  department publication  this or of  and study.  this  his  or  her  Department of  Law  The University of British Columbia 1956 Main Mall Vancouver, Canada V6T 1Y3 Date  DE-6(3/81)  June  2 2 , 1987  that the  representatives.  may be It  thesis for financial gain shall not  permission.  requirements  I further agree  thesis for scholarly purposes by  the  is  an  advanced  Library shall make it  that permission  for extensive  granted  head  by the  understood be  for  that  allowed without  of  my  copying  or  my written  (ii)  ABSTRACT  For most  the last  important  decades,  issues  t r a n s f e r p r i c i n g h a s b e e n one o f t h e  f o r both t a x a u t h o r i t i e s and m u l t i n a t i o n a l  corporations. On  t h e one hand,  measures,  have  not  avoidance o r evasion corporations inability  owing  tax authorities, been  able  using to  to  of tax administrations  the other  hand,  pricing  deficiency  while  of  their  counter-  international tax by  multinational  t a x systems and t h e  and t h i s has r e s u l t e d i n a  revenue l o s s t o t h e c o f f e r s o f t h e i r On  cope w i t h  transfer  the  despite  huge  countries.  multinational  corporations  have  been u s i n g  t r a n s f e r p r i c i n g as v e h i c l e s t o maximize t h e i r o v e r a l l  after-tax  profits  able  as a group,  administrative  burdens  t h e y have been s u f f e r i n g and  double  taxation  intoler-  caused  by  e n f o r c e m e n t o f counter-measures b y t a x a u t h o r i t i e s .  The tion  i s t h e "arm's l e n g t h  parties out  basic principle f o r transfer pricing  that  are not dealing  f o r tax  by  dealing  t h e OECD,  a t arm's l e n g t h  should  be  however, common  t h e U.S.  specific  one c o u l d  T h i s p r i n c i p l e has been and o t h e r  developed  between carried  i n s i m i l a r circumstance had t h e  a t arm's l e n g t h . Canada,  legisla-  that transactions  p u r p o s e s under terms and a t a p r i c e t h a t  r e a s o n a b l y have expected been  principle",  taxation  parties endorsed  countries,  g u i d e l i n e s under t h i s p r i n c i p l e have n o t  been  established  corporations acceptable  among  tax  a u t h o r i t i e s and  even m u l t i n a t i o n a l  themselves cannot always f i n d an arm's l e n g t h  price  to tax a u t h o r i t i e s .  S i n c e the OECD Committee on F i s c a l A f f a i r s i s s u e d the "Transfer  Pricing  authorities, have  been  and  M u l t i n a t i o n a l E n t e r p r i s e s " i n 1979,  multinational corporations making  strenuous  efforts  and to  keep t h e i r corporations At due  all fair  practitioners  to coordinate  share  of  revenue  and  protect  multinational  the  s i t u a t i o n already  and  due  harmonization  of  shows some improvements guidelines  among  appropriate  advice  from t a x p r a c t i t i o n e r s .  Tax  t h e r e have been no  Act  which  p r i c i n g taxation,  and  provides  guidelines general  1987  Revenue  is  expected  uncertainty On  the  and  that  other  than  a c t u a l enforcement has been based  Canada  Although an i n f o r m a t i o n it  there  issued  Information  But,  augment tax  other hand,  circular  will  on  the  on February  Circular  c i r c u l a r does not c a r r y any the  the  p r i n c i p l e s of t r a n s f e r  i n t e r n a l a s s e s s i n g g u i d e l i n e o f Revenue Canada. 27,  However,  and  room f o r p o s s i b l e improvements.  In Canada, Income  tax  to multinational corporations' a p p l i c a t i o n  o f t r a n s f e r p r i c i n g p o l i c y i n a more s e l f - r e s t r i c t e d manner,  is s t i l l  or  from double t a x a t i o n .  t o e f f o r t s f o r the  more  and its  of which enables tax a u t h o r i t i e s t o r e c o v e r  present,  authorities,  tax  tax  f i n d a reasonable  p r a c t i c a l t r a n s f e r p r i c i n g t a x a t i o n system and enforcement,  report  87-2.  l e g a l weight,  eliminate  taxpayers'  compliance. i n Japan,  despite i t s export-oriented  (iv)  economy, with  t h e Japanese t a x a u t h o r i t i e s have n o t been keeping pace  the  internationalization  of  economic a c t i v i t i e s .  i n t r o d u c e d a n t i - t a x haven l e g i s l a t i o n introduced  transfer  pricing  in  taxation  1978,  i n order  system,  to  i n 1986  legislation.  f a i r l y c o n c r e t e p r i c i n g methods have been w r i t t e n tion  Japan  Although  into  legisla-  p e r m i t t h e r e a s o n a b l e enforcement o f t h e new  t h e r e i s much t o be l e a r n e d from t h e e x p e r i e n c e  "advanced" Above provisions  Having  of the  countries. a l l , Canada's of  legislation  the  are  new  experience Japanese  could  transfer  be u s e f u l , pricing  as t h e taxation  s i m i l a r t o those o f t h e Canadian Income Tax A c t  and both c o u n t r i e s have s e v e r a l s i m i l a r i t i e s i n terms  of  their  r e l a t i o n s h i p w i t h t h e U.S.  In problems,  this  thesis,  after  reviewing  t h e background t o these  I w i l l d i s c u s s t h e Canadian t r a n s f e r p r i c i n g  taxation  system and i t s enforcement by l o o k i n g a t each t y p e o f i n t r a - g r o u p t r a n s a c t i o n and t h e c o r r e s p o n d i n g adjustment and mutual procedure  system.  Japanese approach.  agreement  Then I w i l l compare t h e Canadian approach and P o s s i b l e improvements  w i l l be d e a l t  with  in  the c o n c l u s i o n . S i n c e t h e r e has been l i t t l e j u r i s p r u d e n c e i n t h i s area, d i s c u s s i o n s a r e p r i m a r i l y based on t h e t a x a u t h o r i t i e s ' t i v e s and t h e OECD r e p o r t s .  the  perspec-  ( V )  T A B L E O F CONTENTS  CHAPTER I  CHAPTER I I SUBCHAPTER I  SUBCHAPTER I I  SUBCHAPTER I I I  SUBCHAPTER IV  SUBCHAPTER V  INTRODUCTION 1. BACKGROUND 2. THE PROBLEMS WHICH TAX AUTHORITIES ARE FACING AND THEIR COUNTERMEASURES 3. THE PROBLEMS WHICH MULTINATIONAL CORPORATIONS ARE FACING THE CANADIAN TRANSFER PRICING TAXATION SYSTEM OUTLINE OF THE CANADIAN TRANSFER PRICING TAXATION SYSTEM 1. LEGISLATION 2. ARM'S LENGTH PRINCIPLE TRANSFER OF GOODS 1. COMPARABLE UNCONTROLLED PRICE METHOD 2. RESALE PRICE METHOD 3. COST PLUS METHOD 4. OTHER METHODS AND GENERAL CONSIDERATIONS PROVISION OF INTRA-GROUP SERVICES 1. INTRODUCTION 2. JUSTIFICATION OF BENEFITS 3. METHOD OF ALLOCATION AND APPORTIONMENT 4. AMOUNT OF CONSIDERATION 5. SUMMING UP TRANSFER OF TECHNOLOGY 1. INTRODUCTION 2. LICENSING AGREEMENTS 3. COST CONTRIBUTION ARRANGEMENTS FOR R & D EXPENDITURE AMONG MEMBER COMPANIES OF MNCS CORRESPONDING ADJUSTMENT AND MUTUAL AGREEMENT PROCEDURE 1. INTRODUCTION. 2. CORRESPONDING ADJUSTMENT 3. MUTUAL AGREEMENT PROCEDURE 4. SPECIFIC PROCEDURES TO BE TAKEN BY REVENUE CANADA AND CANADIAN TAXPAYERS IN THE MUTUAL AGREEMENT PROCEDURE  Page  1 1 5 7  11 11 11 15 24 24 29 33 36 50 50 51 57 64 66 74 74 76 83 95 95 96 100 115  (vi)  5. CHAPTER I I I  THE JAPANESE NEW TRANSFER PRICING TAXATION SYSTEM 1. BACKGROUND 2. OVERVIEW OF THE SYSTEM 3. ADMINISTRATIVE PRINCIPLES AND GUIDELINES 4.  CHAPTER IV  SUMMING UP  COMPARISON OF THE JAPANESE SYSTEM AND CANADIAN SYSTEM  122 129 129 130 147 153  CONCLUSION 1. INTRODUCTION  165 165  2. 3. 4.  166 184 189  SELECTED BIBLIOGRAPHY  POSSIBLE IMPROVEMENTS KEY CONSIDERATIONS TO BE GIVEN FINAL REMARKS  193  (vii)  ACKNOWLEDGEMENT  This thesis  could  not  warm-hearted encouragement  have  been  completed  without  the  and expert guidance o f P r o f e s s o r M. J .  O'Keefe. I am much o b l i g e d t o P r o f e s s o r M. Smith, t h e former D i r e c t o r of t h e  Japanese  Legal  Studies,  Professor  M.  T.  MacCrimmon,  P r o f e s s o r H. Kaneko, Tokyo U n i v e r s i t y and Mr. Y. Gomi, t h e former Deputy Commissioner me  an  o f t h e N a t i o n a l Tax A d m i n i s t r a t i o n f o r g i v i n g  opportunity  for  studying  at  the U n i v e r s i t y of B r i t i s h  Columbia. I  a l s o wish t o thank  Revenue Canada, T a x a t i o n  me t o make r e s e a r c h e s a t t h e Head O f f i c e and a t t e n d at Vancouver D i s t r i c t Finally, for  f o r allowing t h e seminars  Office.  I am g r a t e f u l t o t h e U n i v e r s i t y o f B r i t i s h  i t s financial  Columbia  a s s i s t a n c e and the s t a f f o f the F a c u l t y o f Law  at the U n i v e r s i t y of B r i t i s h  Columbia.  To them I express my h e a r t y g r a t i t u d e .  1  CHAPTER I INTRODUCTION  1.  BACKGROUND  As  a  economic have  consequence activities,  become  of  can  be  rapid  economic  entities.  In  1  transactions  a  multinational  take  place  s u b s i d i a r i e s abroad,  some member mediates member  companies  operating  corporation  of  the  parent  measure,  only  from  ("MNC"),  producing  manufacture  many  A large  subsidiaries  and i n v e r t i c a l l y  to  i n t e g r a t e d MNCs,  components  group.  or  inter-  I t can be s a i d t h a t i n t e r n a l i z a t i o n and  transactions are,  company.  And  controlled  MNCs are i n a p o s i t i o n t o adopt any relevant  such a measure would b e n e f i t them.  importance f o r MNCs t o  transactions.  more o r l e s s  which w i l l a l l o w them t o conform t o  laws, whenever vital  national  which w i l l be assembled o r f u r t h e r p r o c e s s e d by another 2  Such i n t r a - g r o u p a  which are  across  i n t e r n a t i o n a l i z a t i o n are the main f e a t u r e s o f MNC  by  multinational  between members o f the group.  amount o f goods may be shipped selling  A  corporations"  d e f i n e d as a group o f companies,  l e g a l l y autonomous but i n t e r r e l a t e d , borders.  i n t e r n a t i o n a l i z a t i o n of  the s o - c a l l e d " m u l t i n a t i o n a l  powerful  corporation  the  maximize  their  Since  overall  national i t i s of after-tax  p r o f i t s as a group, t h e t r a n s f e r p r i c i n g , which can be d e f i n e d as the  pricing  arrangement i n i n t r a - g r o u p  t r a n s a c t i o n s has been an  2  i n t e g r a l p a r t of MNCs  tax p l a n n i n g .  1  fix  the  prices  in  their  3  That i s  t o say,  MNCs  may  i n t r a - g r o u p t r a n s a c t i o n s a g a i n s t the  i n t e r e s t s o f the i n d i v i d u a l member companies a t the d i s c r e t i o n of the  parent  increased.  company In  if  their  addition  to  overall  the  MNCs  1  after-tax ability  profit  to  is  manipulate  t r a n s f e r p r i c e s , t h e r e are a number of inducements t o make such a price  manipulation. First,  maximize  d i f f e r e n t r a t e s of c o r p o r a t e taxes may  after-tax  profits  of  MNCs.  For  contribute to  example,  if  the  c o r p o r a t e tax r a t e i n Country A i s h i g h e r than t h a t i n Country assuming o t h e r circumstances  are equal,  overall  by  after-tax  profits  a MNC  can  increase  underpricing  the  sales  s u b s i d i a r y i n Country A t o i t s o t h e r  subsidiary  in  B, its  by i t s  Country  B.  Even i f the tax r a t e s are the same, as l o n g as d i f f e r e n c e s i n tax laws such as an a c c e l e r a t i v e d e p r e c i a t i o n , investment etc. the  exist,  t h e r e would s t i l l be inducements.  transaction  countries,  the  takes  place  transfer  with  pricing  credit,  Above a l l ,  subsidiaries scheme  tax  in  becomes  when  t a x haven even  more  tempting. Second, country,  i n order to avoid withholding  MNCs may  manipulate  payments which would be example,  to  taxes  in  the  host  t h e i r t r a n s f e r p r i c e s t o reduce the  subject  to  the  withholding  tax.  a v o i d the w i t h h o l d i n g tax on d i v i d e n d s ,  company c o u l d reduce the p r o f i t of the s u b s i d i a r y  r e l e v a n t t a x t r e a t y exempts the  withholding  tax  the parent  and  therefrom by o v e r p r i c i n g the s a l e t o the s u b s i d i a r y .  dividends Or,  on  f e e s , MNCs d i s g u i s e o t h e r payments as management f e e s .  For  i f the  management 5  3  T h i r d , custom d u t i e s might make MNCs manipulate t h e t r a n s f e r prices.  Developing  on f i n i s h e d goods, parent  countries  u s u a l l y impose h i g h  and t o a v o i d  such  high  import  import  duties  the  company may u n d e r p r i c e t h e s a l e s t o i t s s u b s i d i a r y i n t h e  c o u n t r y imposing h i g h Fourth,  where  remittances  in a  import MNCs  duties.  suffer  6  from  p a r t i c u l a r country,  restrictions  on  In  addition  to  t h e above-mentioned inducements,  p r i c i n g c o u l d be used f o r t h e f o l l o w i n g augment  a  MNCs  1  venture  through  p a r e n t company t o t h e j o i n t v e n t u r e ; wage r a i s e s i n a s u b s i d i a r y by  to  overpricing  t o deter  that  transfer keep  or  decreasing  t o pay  by t h e  l a b o r demands f o r  the p r o f i t s  t o compensate t h e "country r i s k " ,  on investment o r  country  purposes:  in  share o f p r o f i t s i n a j o i n t v e n t u r e by r e d u c i n g  the p r o f i t s o f t h e j o i n t  subsidiary;  profit  they may circumvent t h i s  r e s t r i c t i o n by o v e r p r i c i n g t h e s a l e s t o t h e s u b s i d i a r y 7 country.  returns  duties  of the  i . e . t o get f a s t  out c a p i t a l  where  t h e host  i s p o l i t i c a l l y u n s t a b l e o r tends t o n a t i o n a l i z e f o r e i g n  corporations;  t o finance  foreign  subsidiaries;  infant subsidiary; t o f a c i l i t a t e penetration  to  support  an  i n new markets; and,  o  t o a v o i d exchange c o n t r o l s . On  t h e o t h e r hand,  abilities  t o manipulate  countermeasures  taken  t h e r e a r e s e v e r a l c o n s t r a i n t s on MNCs' transfer by  prices.  In  tax authorities,  addition the  to  following  c o n s t r a i n t s which a r e i n t e r n a l t o MNCs themselves may e x i s t . First, necessary  i n most for  MNCs  effective  the decentralized management  and  organizaton  is  s u b s i d i a r i e s are  4  established  as  autonomous  profit  9  centers.  Where t h e " p r o f i t  c e n t e r " concept i s adopted by a MNC, s i n c e t h e p r o f i t of each s u b s i d i a r y i s assessed achieved  itself,  local  p r i c i n g manipulation subsidiary accounts  unless which  subsidiary.  t h e parent  the costs  expensive f o r MNCs; large  might  amount  other.  of  the  are l i k e l y t o r e s i s t reduce  company  the real  the p r o f i t s keeps  profit  of  o f manipulating  of the set of  performance  of the  transfer  prices  central  are  p l a n n i n g and d e c i s i o n making which 1 1  t h e above-mentioned inducements c o n f l i c t  F o r example,  profit  transfer  another  with  each  where a parent company o v e r p r i c e s t h e goods  s o l d t o i t s f o r e i g n subsidiary i n order t o avoid the on  profits  f o r example, such m a n i p u l a t i o n would r e q u i r e  might be c o u n t e r - p r o d u c t i v e . Third,  the basis  1 0  Second,  a  managers  which  records  on  performance  repatriation  by  restriction  t h e host country o f t h e s u b s i d i a r y ,  t h i s m a n i p u l a t i o n may i n c r e a s e t h e p r o f i t s  of  t h e p a r e n t company 12  and a l s o i n c r e a s e t h e import d u t i e s o f t h e s u b s i d i a r y . Considering  these c o n s t r a i n t s ,  i t cannot be s a i d t h a t MNCs  have u n m i t i g a t e d "freedom" t o manipulate have  to  anticipate  some  disadvantages  transfer prices for particular whether o r not,  transfer when  t a x purposes.  prices.  they The  MNCs  manipulate decision  on  o r how t o manipulate must depend on t h e order o f  p r i o r i t y o f t h e o b j e c t s which t h e MNC wants t o pursue.  5  2.  THE  PROBLEMS WHICH TAX  AUTHORITIES ARE  FACING  AND  THEIR COUNTERMEASURES  Although  MNCs  cannot  always manipulate t r a n s f e r p r i c e s  they want because of v a r i o u s c o n s t r a i n t s , t h a t MNCs have been s u c c e s s f u l  words,  the c o f f e r s of the developed c o u n t r i e s share  proliferation indicates  of  how  of  of  1  companies  and  recognized  overall  developed c o u n t r i e s .  revenue owing t o MNCs  "paper"  easy  the  t o be  their  at  fair  expense  i n minimizing  burden  their  the  i t has  in  tax  have  as  tax  In other  been  losing  tax p l a n n i n g . haven  The  countries  tempting i t i s f o r MNCs t o s h i f t t h e i r  t a x a b l e p r o f i t s i n t o the  tax haven  subsidiaries  by  using  the  t r a n s f e r p r i c i n g schemes. To MNCs,  cope w i t h such i n t e r n a t i o n a l tax avoidance or e v a s i o n tax a u t h o r i t i e s have i n t r o d u c e d  administrative  counter-measures.  The  several  legislative  "transfer pricing  system" i s thought t o be the most e f f e c t i v e measure. of t h i s  system  country, as  transaction upon  Where  the  of a MNC  the  between  a u t h o r i t i e s can  adjust  arm's l e n g t h  specific  legislation  taxation details of  speaking, t h i s system can be  internal  price  in  an  and  each  defined  intra-group  d i f f e r s from the p r i c e which would have been  s i m i l a r circumstances  on the  on  however, g e n e r a l l y  follows:  agreed  depend  The  by  unrelated  parties  ("arm's l e n g t h  engaged i n the  price"),  the  same or  relevant  the a c t u a l p r i c e of the t r a n s a c t i o n ,  price,  or d i s t r i b u t e ,  a p p o r t i o n or  tax based  allocate  g r o s s income, d e d u c t i o n s or c r e d i t s among the members of the  MNC.  6 Among t h e developed advanced  country  countries,  i n this  area.  t h e U.S. Although  transfer pricing taxation legislation,  has been t h e most  t h e U.S.  which  introduced  i s equivalent  to  S e c t i o n 482 o f t h e p r e s e n t U.S. I n t e r n a l Revenue Code ("IRC"), i n 1928,  t h e I n t e r n a l Revenue S e r v i c e ("IRS")  weapon f o r a l o n g time. ("IRC arm's  Regulation"),  has  used  this  However, a f t e r t h e Income Tax R e g u l a t i o n  which p r o v i d e s t h e methods  length prices,  not  was enacted  i n 1968,  f o r calculating  t h e IRS began r a t h e r  i n t e n s i v e and a g g r e s s i v e enforcement o f t h e l e g i s l a t i o n  and has  been s u c c e s s f u l i n i n c r e a s i n g revenue, and a t l e a s t i n p r e v e n t i n g the s h i f t i n g o f t a x a b l e p r o f i t s abroad. Like other countries, its  several  Canada has f o l l o w e d t h e U.S.  Among  weapons f o r t a c k l i n g i n t e r n a t i o n a l t a x avoidance o r 13  e v a s i o n by MNCs, at  S e c t i o n 69 o f t h e Income Tax A c t aims d i r e c t l y  the t r a n s f e r p r i c i n g .  to  actively  techniques, cooperation  enforce training  1 4  with  Revenue Canada has been making Section  69  i t s field  foreign  by  introducing  auditors  tax authorities,  and  efforts  new  audit  developing  e s p e c i a l l y with the  IRS. At p r e s e n t ,  although t h e r e i s s t i l l  plenty  of  room f o r  i n t e r n a t i o n a l t a x p l a n n i n g u s i n g t r a n s f e r p r i c i n g by MNCs, i t can be  said  that  tax authorities  have developed  fairly  effective  counter-measures t o cope w i t h such i n t e r n a t i o n a l t a x avoidance evasion.  or  7  3.  THE PROBLEMS WHICH MNCS ARE FACING  It  has  to avoid though  t o be r e c o g n i z e d t h a t every MNC w i l l n o t always t r y  o r evade  t a x by  manipulating  transfer  prices.  Even  t h e p o s s i b i l i t y o f m i n i m i z i n g t h e o v e r a l l MNC t a x burden  i s tempting,  MNCs might a t l e a s t  t r y to  conform  to  relevant  domestic laws i n t h e i r t a x p l a n n i n g . Owing  to  transfer  pricing  taxation  a g g r e s s i v e enforcement by t a x a u t h o r i t i e s , harsh  assessments  by  tax authorities  l e g i s l a t i o n and  the p o s s i b i l i t y and  double  of  taxation 15  t h e r e f r o m has i n c r e a s e d The  even i n t h e case o f "honest" t a x p a y e r s .  s p e c i f i c methods used t o c a l c u l a t e an arm's l e n g t h  p r o v i d e d by t a x laws a r e t o o g e n e r a l t o be h e l p f u l . might  even  guideline of  be  length  i n every case.  prices  has  I n t h e end,  been  made  a r e s u l t , i t i s very d i f f i c u l t ,  to  tax authorities.  of  t h e MNC,  have made a c o r r e s p o n d i n g unrelieved In  double  response  Multinational  p r i c e which  on  unless other relevant adjustment, 18  facts  and  1 6  Furthermore,  a u t h o r i t y made a t r a n s f e r p r i c i n g adjustment transaction  on  sometimes even i m p o s s i b l e  f o r MNCs themselves t o f i n d an arm's l e n g t h 17 acceptable  the calculation  based  c i r c u m s t a n c e s t e s t i n each case i n p r a c t i c e . As  In f a c t , i t  i m p o s s i b l e f o r t a x a u t h o r i t i e s t o make a g e n e r a l  applicable  arm's  price  t h e MNC  will  where an  be  one t a x  intra-group  tax authorities has  to  suffer  taxation. to  t h e OECD  Enterprises"  Report  "Transfer  ("OECD R e p o r t " ) ,  MNCs  Pricing complained  and of  8  the  deficiencies  double t a x a t i o n relieve  MNCs  of  t h e p r e s e n t system and t h e s e r i o u s n e s s o f  and urged t h e OECD t o make from double t a x a t i o n .  suggestions are not e n t i r e l y observe  interests  authorities and  o f MNCs  i n considering  i t s enforcement.  well  efforts  to  Although t h e i r o p i n i o n s and  acceptable, as  further  as  i t i s necessary  to  the interests of tax  a reasonable t r a n s f e r  pricing  system  9  CHAPTER I - FOOTNOTES  1  S. R. F. P l a s s c h a e r t , T r a n s f e r P r i c i n g and M u l t i n a t i o n a l Corporations: an overview o f concepts, mechanisms and r e g u l a t i o n s , Saxon House (1979), a t 3  2  Ibid. 3  3  T r a n s f e r P r i c i n g and M u l t i n a t i o n a l E n t e r p r i s e s , Report o f t h e OECD Committee on F i s c a l A f f a i r s (1979), a t p a r a . 2  4  J . S. Peterson, I n t e r n a t i o n a l T r a n s f e r P r i c i n g : A Canadian Perspective, Report o f t h e Proceedings o f t h e T h i r t y - F i r s t Tax Conference. Canadian Tax Foundation (1979), a t 452  5  I b i d . 452  6  Supra. note 1, a t 6  7  Supra. note 1, a t 6-7  8  Supra, note 4, a t 452-453  9  Supra, note If a t 23-24  10  Supra. note i f  11  Supra. note If a t 73-74  12  Supra. note If a t 75-76  13  Revenue Canada can use, f o r example, as a s t a t u t o r y antiavoidance p r o v i s i o n , t h e "FAPI" (foreign accrual property income) r u l e (subparagraph 95(2)(b) o f t h e Income Tax A c t ) , and as j u d i c i a l a n t i - a v o i d a n c e d o c t r i n e s , a " p l a c e o f c e n t r a l management and c o n t r o l " test o f c o r p o r a t e r e s i d e n c e and a "sham" d o c t r i n e .  14  Revenue Canada has i n t r o d u c e d t h e " i n d u s r t y - w i d e " a u d i t s , t h e " l a r g e f i l e " program (team a u d i t s ) and t h e "simultaneous" audits.  15  Supra, note 3, a t p a r a . 4  16  Supra, note 3, a t p a r a . 5  17  Transfer Pricing, Corresponding Adjustments and t h e Mutual Agreement Procedure, T r a n s f e r Pricing and M u l t i n a t i o n a l Enterprises: Three T a x a t i o n I s s u e s , Report o f t h e OECD  a t 7-8  10 Committee on F i s c a l A f f a i r s I b i d , p a r a . 25  (1984), a t p a r a .  11  CHAPTER I I THE CANADIAN TRANSFER PRICING TAXATION SYSTEM SUBCHAPTER I OUTLINE OF THE CANADIAN SYSTEM  1.  LEGISLATION  Framework o f S e c t i o n 69 As  stated  before,  t h e Canadian  version  of the t r a n s f e r  p r i c i n g t a x a t i o n system i s p r o v i d e d i n S e c t i o n 69 o f t h e Income Tax A c t ("ITA"). S e c t i o n 69 (1) Except as e x p r e s s l y otherwise p r o v i d e d i n t h i s A c t , (a) where a taxpayer has a c q u i r e d a n y t h i n g from a person w i t h whom he was n o t d e a l i n g a t arm's l e n g t h at an amount i n excess o f t h e f a i r market v a l u e t h e r e o f a t t h e time he so a c q u i r e d i t , he s h a l l be deemed t o have a c q u i r e d i t a t t h a t f a i r market v a l u e ; (b) where a taxpayer has d i s p o s e d o f a n y t h i n g (i) t o a person w i t h whom he was n o t d e a l i n g a t arm's length f o r no proceeds o r f o r proceeds l e s s than the f a i r market v a l u e t h e r e o f a t t h e time he so disposed of i t , or ( i i ) t o any person by way o f g i f t i n t e r v i v o s , he shall be deemed t o have r e c e i v e d proceeds o f d i s p o s i t i o n t h e r e f o r equal t o t h a t f a i r market v a l u e ; and (c) where a taxpayer has a c q u i r e d p r o p e r t y by way o f gift, bequest o r i n h e r i t a n c e , he s h a l l be deemed t o have a c q u i r e d t h e p r o p e r t y a t i t s f a i r market v a l u e at t h e time he so a c q u i r e d i t . Subsection  (1) a p p l i e s t o non-arm's l e n g t h a c q u i s i t i o n s and  d i s p o s i t i o n s o f "anything".  Paragraph (a) means t h a t t h e c o s t o f  a c q u i s i t i o n may n o t f o r t a x purposes exceed f a i r market v a l u e and paragraph  (b) means t h a t t h e proceeds o f d i s p o s i t i o n may n o t  for  12  tax purposes be l e s s than f a i r market v a l u e . (2) Where a taxpayer has p a i d o r agreed t o pay t o a n o n - r e s i d e n t person w i t h whom he was n o t d e a l i n g a t arm's l e n g t h as p r i c e , rental, royalty or other payment f o r o r f o r t h e use o r r e p r o d u c t i o n o f any property, o r as c o n s i d e r a t i o n f o r t h e c a r r i a g e o f goods o r passengers o r f o r o t h e r s e r v i c e s , an amount g r e a t e r than t h e amount ( i n t h i s s u b s e c t i o n r e f e r r e d to as "the reasonable amount") t h a t would have been r e a s o n a b l e i n t h e circumstances i f t h e n o n - r e s i d e n t person and t h e taxpayer had been d e a l i n g a t arm's l e n g t h , t h e reasonable amount s h a l l , f o r t h e purpose of . computing t h e taxpayer's income under t h i s P a r t , be deemed t o have been t h e amount t h a t was p a i d o r i s payable t h e r e f o r . (3) Where a n o n - r e s i d e n t person has n e i t h e r p a i d , nor agreed t o pay t o a taxpayer w i t h whom he was n o t d e a l i n g a t arm's l e n g t h as p r i c e , r e n t a l , royalty or o t h e r payment f o r o r f o r t h e use o r r e p r o d u c t i o n o f any p r o p e r t y , o r as c o n s i d e r a t i o n f o r t h e c a r r i a g e o f goods o r passengers o r f o r o t h e r s e r v i c e s , t h e amount t h a t would have been reasonable i n t h e c i r c u m s t a n c e s if t h e n o n - r e s i d e n t person and t h e taxpayer had been d e a l i n g a t arm's l e n g t h , t h a t amount s h a l l , f o r the purpose o f computing t h e taxpayer's income under t h i s Part, be deemed t o have been r e c e i v e d o r r e c e i v a b l e by t h e taxpayer t h e r e f o r . Where  a t r a n s a c t i o n takes p l a c e between a Canadian taxpayer  and a n o n - r e s i d e n t dealing  at  with  arm's  whom  length,  t h e Canadian these  subsections  Subsection  (2) means t h a t t h e amount t h a t t h e  has  or  paid  taxpayer  was not  will  Canadian  apply. taxpayer  agreed t o pay t o t h e r e l a t e d n o n - r e s i d e n t may not,  f o r t a x purposes,  exceed a reasonable  subsection  means  (3)  that  arm's  t h e amount  length that  price  and  the related  n o n - r e s i d e n t has p a i d o r agreed t o pay t o t h e Canadian  taxpayer  may not, f o r t a x purposes, be l e s s than a r e a s o n a b l e arm's l e n g t h price.  2  13 " F a i r market v a l u e " v s . "reasonable arm's l e n g t h p r i c e " According  to  Revenue  Canada,  subsections  3 o v e r r i d e s u b s e c t i o n (1), although some t a x that  same  (3)  4  I t must be  whether a " f a i r market v a l u e " i n s u b s e c t i o n (1)  a "reasonable the  .  t h e r e i s no a u t h o r i t y f o r such o v e r r i d i n g .  be c l a r i f i e d  and  . . . practitioners point .  out  (2)  arm's l e n g t h p r i c e " i n s u b s e c t i o n s  or  not.  The reason why  (2) and  and  (3) are  l e g i s l a t o r s have not used the  f a i r market v a l u e terminology but the d i f f e r e n t terminology, amount t h a t would have been reasonable the  non-resident  person  arm's l e n g t h " i s thought arm's l e n g t h p r i c e may depending say, or  than  "reasonable  the  the  circumstances  the  Revenue  Canada  that  a  reasonable  mean a f a i r market v a l u e or another  may  fair  i n a p a r t i c u l a r case.  length  market price".  amount  That i s t o than  v a l u e can be e s t b l i s h e d as the For example,  an i n t r a - g r o u p  take p l a c e a t lower than t h e f a i r market  value  order to help a r e l a t e d e n t i t y i n f i n a n c i a l d i f f i c u l t i e s ,  i n c r e a s e i t s share i n e x i s t i n g markets, t o i n t r o d u c e new i n t o markets, or t o fend o f f i n c r e a s i n g c o m p e t i t i o n . be s a i d t h a t whereas the f a i r market v a l u e determined  f o r many products,  arm's l e n g t h p r i c e a p p r o a c h .  if  taxpayer had been d e a l i n g a t  be s i t u a t i o n s where the p r i c e which i s more  arm's  s a l e o f a MNC in  by  on the circumstances  t h e r e may less  and  in  "the  cannot  to  products  I t a l s o can be  precisely  i t might be p r a c t i c a l t o adopt the 6  However, i n J . H o f e r t L i m i t e d v. 7 Revenue. the Tax Appeal Board s t a t e d :  Minister  of  National  I d i s c e r n l i t t l e i f any, p r a c t i c a l d i f f e r e n c e between "fair price" [i.e., reasonable arm's l e n g t h p r i c e ] and  14 "fair market v a l u e " and c o n s i d e r t h a t the o b s e r v a t i o n o f Maclean, J . [i.e., " f a i r p r i c e " was commercial and not a l e g a l term and i n v o l v e d a q u e s t i o n of f a c t i n t o which many c o n s i d e r a t i o n s might enter] have equal applicability t o the question r a i s e d i n t h i s instant matter. 8 In a d d i t i o n , Revenue Canada has t h e o r i e s and  s t a t e d t h a t i t uses the same  p r i n c i p l e s of t r a n s f e r p r i c i n g t o determine the  fair 9  market v a l u e under s u b s e c t i o n the end, (  t h e r e may  in  taxpayers  transfer pricing, represent  Since subsection  (3).  practice, to  take  Revenue a  Canada  "clean  concepts.  seems  price"  In  to  be  approach  to  t h a t i s , t o e s t a b l i s h intercompany p r i c e s t h a t  only f a i r  involved.)  (2) and  be l i t t l e d i f f e r e n c e between the two  Interestingly,  encouraging  (1) as s u b s e c t i o n  market  value  of  the  product  or  service  1 0  in  the case o f i n t e r n a t i o n a l t r a n s f e r p r i c i n g ,  (2) and  (3) apply,  i n t h i s paper,  only  a "reasonable arm's  l e n g t h p r i c e " i s the p r i n c i p a l focus. What i s a r e a s o n a b l e arm's l e n g t h p r i c e ? The general the  Canadian Income Tax A c t o n l y s t a t e s the above-mentioned principles.  U.S.  IRC  There have not been any  Regulation  which  states  c a l c u l a t i n g the arm's l e n g t h p r i c e . Canadian t a x p a y e r can use in  a  making  "reasonable transfer  assessing available  and  pricing  clear  specific would  such as  methods  appear  that  for the  any method of c a l c u l a t i o n i f i t r e s u l t s  amount".  guideline.  It  guidelines  However,  adjustments In  for  the  past  taxpayers  Revenue based this so  Canada on  its  guideline  that  they  has  been  internal was  not  have  had  15  difficulties taxpayers  in  and  fixing  tax  transfer  p r a c t i t i o n e r s have  p u b l i c a t i o n of c l e a r g u i d e l i n e s . Eventually, 87-2  ("IC  international  transactions.  procedures  Canada and has no l e g a l  impact.  the  specific  Considering  to  be  pricing  there  which d i r e c t l y d e a l s w i t h how length  price",  it  might  be  and  requested  the  Circular  No.  has  Information pricing  long-awaited followed  methods  b a s i c a l l y f o l l o w e d the OECD Report and reasonable.  certainty  strongly  transfer  This  c i r c u l a r only provides  However,  with  1 1  Revenue Canada i s s u e d  87-2") on  international  prices  little  other  information by  provided  i t s contents been  and  seem  Revenue  in  fairly  jurisprudence  t o c a l c u l a t e the "reasonable  2.  circular.  ARM'S LENGTH PRINCIPLE  Arm's l e n g t h p r i n c i p l e Paragraph 9 o f IC 87-2  arm's  a p p r o p r i a t e t o d i s c u s s the a c t u a l  a p p l i c a t i o n o f the arm's l e n g t h p r i n c i p l e i n Canada based on information  it  states that  the "arm's l e n g t h p r i n c i p l e " , i n the context of t r a n s a c t i o n s between p a r t i e s t h a t are not i n fact dealing a t arm's l e n g t h , means t h a t each such transaction should be c a r r i e d out under terms and a t a p r i c e t h a t one could reasonably expect in similar circumstances ... had the p a r t i e s been d e a l i n g a t arm's length.  this  16 T h i s p r i n c i p l e and t h e b a s i c methods f o r f i n d i n g length U.S.  price  are the  t h e arm's  same as those o f t h e OECD Report and t h e  system. An  price  i d e a l p r i c i n g method f o r i s arrived  at  by  calculating  referring  to  t h e arm's  prices  t r a n s a c t i o n s between independent c o r p o r a t i o n s  in  length  comparable  o r between a member  12 of  a  MNC  and  an  unrelated  party.  I f this  "comparable  u n c o n t r o l l e d p r i c e " method i s not a v a i l a b l e o r n o t reasonable apply,  as  secondary methods,  t h e " r e s a l e p r i c e " method,  s t a r t s w i t h t h e f i n a l s e l l i n g p r i c e and s u b t r a c t s an p r o f i t mark-up, cost of  methods  t h e goods  or  of  services 13  p r o f i t mark-up c o u l d be used.  are not  available  or  appropriate  e t c . and  adds  properties,  such  other  Necessary c o n s i d e r a t i o n t o be  i n a p p l y i n g these p r i c i n g methods w i l l d i f f e r i n each  transaction,  an  Where these secondary  n o t reasonable t o apply,  methods would have t o be employed. given  which  o r t h e " c o s t p l u s " method, which s t a r t s w i t h t h e  providing  appropriate  to  type  as t h e t r a n s f e r o f t a n g i b l e o r i n t a n g i b l e  t h e p r o v i s i o n o f s e r v i c e s and t h e use o f i n t a n g i b l e  properties. Before l o o k i n g i n t o more p r e c i s e l y , t h e r e a r e s e v e r a l  issues  t o be mentioned. Functional It operation The  Analysis i s of  vital  importance  o f a MNC r a t h e r than t o  OECD Report s t a t e s :  to look  understand  the o v e r a l l  into  transaction.  each  17  When examining t h e t r a n s f e r p r i c e s adopted w i t h i n a MNE, i t i s always u s e f u l t o b e g i n by a n a l y s i n g t h e function of the various e n t i t i e s which comprise t h e MNE. Some f a m i l i a r i t y with the structure and organization o f t h e group and some knowledge o f which e n t i t i e s undertake t h e r i s k s and r e s p o n s i b i l i t i e s f o r the various activities are essential f o r tax a u t h o r i t i e s t o h e l p them i n a s s e s s i n g when a p r o f i t i s l i k e l y t o a r i s e and roughly what s o r t o f i t i s i k e l y t o be. 14 Revenue usefulness  Canada seems t o f u l l y understand t h e importance and  o f a f u n c t i o n a l a n a l y s i s as a  taken by i t s f i e l d a u d i t o r s . be  useful  necessary  step  t o be  A f u n c t i o n a l a n a l y s i s w i l l not only  f o r f i n d i n g a reasonable arm's l e n g t h p r i c e but a l s o  f o r f a c i l i t a t i n g e f f e c t i v e and p r o d u c t i v e functional  analysis  i s indispensable  audits.  Especially,  a  f o r f i n d i n g an a p p r o p r i a t e  mark-up o r a reasonable a l l o c a t i o n o f p r o f i t s among members o f a 15 MNC.  Package Deal It  i s common  transactions  to  find  "package  in  intra-group  o f MNCs t h a t i n which a s i n g l e charge i s made f o r a  variety of benefits.  F o r example,  products  subsidiary  to  administrative  deals"  its  services  undifferentiated  or  payment.  other Since  a parent company with  various  benefits tax  might  technical  i n return treatments  i n d i v i d u a l types o f b e n e f i t s d i f f e r from country t o  sell and  f o r an f o r the  country, i t  is  v e r y d i f f i c u l t t o d e a l w i t h a package d e a l as one t r a n s a c t i o n  in  calculating  Canada, be  an  arm's  length  f o l l o w i n g t h e OECD Report,  price.  1 6  Therefore,  Revenue  r e q u i r e s each t r a n s a c t i o n t o  i n d e n t i f i e d as a s e p a r a t e t r a n s f e r and as a r e s u l t be s u b j e c t  18 t o a s e p a r a t e e v a l u a t i o n and intercompany  charge.  Paragraph  10  of IC 87-2 s t a t e s : A s e p a r a t e i d e n t i f i c a t i o n and v a l u a t i o n o f t h e v a r i o u s p r o d u c t s and s e r v i c e s w i l l not o n l y f a c i l i t a t e the audit of international transactions but w i l l a l s o , where an income t a x t r e a t y o r c o n v e n t i o n i s i n f o r c e , assist the t r e a t y partners i n t h e i r negotiations to a v o i d double t a x a t i o n . This  approach  comforms t o Revenue Canada's  "tansaction-by-  t r a n s a c t i o n " approach. On t h e o t h e r hand, opposing  this  impossible separate  MNCs and  approach.  It  tax practitioners  i s very  difficult  and  and charge them  separately.  approach i t s e l f c o n t a i n s t h e danger o f unreasonable One  seem unreasonable when analyzed but  a  a  transaction"  assessments.  opinion,  as  according  unnecessary  their  deal  Furthermore,  and  to  evaluate  been  and sometimes  t o i d e n t i f y s e v e r a l elements i n a package transaction  have  particular  apart  form  "transaction-by-  transaction  other  may  transactions,  when t h e o v e r a l l maximization o f t h e p r o f i t o f t h e e n t i t y i n  the l o n g run i s taken reasonable.  In  into  addition,  "transaction-by-transaction"  account, there  the  transaction  may  be  i s no l e g a l a u t h o r i t y f o r t h e  approach under  Section  69  o f the  17 Income Tax A c t . In response t o t h e above-mentioned c r i t i c i s m , Revenue Canada has  admitted t h e n e c e s s i t y o f  cases.  modifying  i t s approach  i n some  Paragraph 11 o f IC 87-2 s t a t e s :  If t h e above [ t r a n s a c t i o n - b y - t r a n s a c t i o n ] approach i s not p r a c t i c a l o r proves u n r e a l i s t i c i n terms o f t h e manner i n which t h e p a r t i c u l a r i n d u s t r y conducts i t s  19 business, then t h e taxpayer should be prepared t o provide, i n a comprehensive statement o f intercompany pricing policy, t h e b a s i s on which t r a n s f e r p r i c e s a r e e s t a b l i s h e d world-wide. And  where  i t i s i m p o s s i b l e t o analyze on a t r a n s a c t i o n - b y -  transaction basis, analyze  Revenue Canada  may  allow  t h e taxpayer  to  t h e p r i c i n g o f a p a r t i c u l a r product d u r i n g t h e year,  or  18 to  focus on a p a r t i c u l a r product  l i n e , and so on.  Set-offs In c o n n e c t i o n w i t h package transaction  approach,  deals  there  i s the  and  the  transaction-by-  f u r t h e r problem o f how t o  t r e a t s e t - o f f arrangements i n i n t r a - g r o u p t r a n s a c t i o n s Although  the size  arrangements can be  and  extent  found  of  MNCs.  of a set-off w i l l d i f f e r ,  such  i n transactions  between  unrelated  19 p a r t i e s as w e l l as w i t h i n MNCs. IC 87-2 does not d e a l w i t h t h i s i s s u e , however, its  transaction-by-transaction  approach,  considering  Revenue  Canada  s c r u t i n i z e t h e s e t - o f f arrangements o f MNCs t o determine the  benefits  can be  accurately  quantified  whether they do i n f a c t balance each o t h e r time,  and  the  final  judgement  will  over  depend  whether 20  i n advance an on  a  will  and  appropriate reasonably  a c c e p t a b l e assessment o f what would be an arm's l e n g t h p r i c e f o r 21 a l l the relevant transactions. On t h e o t h e r hand, the c h a r a c t e r o f  i n t h e U.S., i f t h e s e t - o f f would change  t h e income, t h e items would be taken into 22 account s e p a r a t e l y . I f a p p r o p r i a t e , t h e IRS may make adjustments 23 even i f no u l t i m a t e income was r e a l i z d by t h e group as a whole.  20  Minor adjustments and s u b s t i t u t i o n o f methods The OECD Report  states,  if t h e p r i c e s a c t u a l l y p a i d can be s u b s t a n t i a t e d by a c c e p t a b l e evidence as b e i n g arm's l e n g t h p r i c e s t h e r e would be no j u s t i f i c a t i o n f o r s e e k i n g t o make merely minor o r marginal adjustment t o them f o r t a x purposes. Similarly a t a x a u t h o r i t y should h e s i t a t e t o d i s t u r b without good reason a p r i c i n g arrangement reasonably and c o n s i s t e n t l y operated i n comparable d e a l i n g s w i t h independent p a r t i e s . 24 This  consideration  is  recognized  as  reasonable  i n d i s p e n s a b l e by n o t o n l y MNCs but a l s o t a x a u t h o r i t i e s . Canada  does  not  seem  d i f f e r e n c e s between prices.  Rather  to  actual  i t tries  be  concerned  transfer to  with small  prices  concentrate  and  on  and  Revenue  percentage  arm's  length  t h e areas where  p r i c i n g d i f f e r e n t i a l o r p o t e n t i a l i s s u b s t a n t i a l i n o r d e r t o keep audits  efficient.  S p e c i f i c methods t o c a l c u l a t e t h e arm's l e n g t h p r i c e Despite  tax authorities'  strenuous  efforts  to  s e t out  s p e c i f i c p r i c i n g r u l e s , the determination of t h e reasonable length  price  arm's  i s a q u e s t i o n o f f a c t and should be based on each 25  taxpayer's  own p a r t i c u l a r circumstances  as mentioned b e f o r e ,  and m e r i t s .  under t h e Canadian Income Tax A c t , t h e r e i s  no l e g a l a u t h o r i t y t o r e q u i r e taxpayers t o use provided  In a d d i t i o n ,  specific  methods  i n IC 87-2 and t h e r e i s l i t t l e d i r e c t j u r i s p r u d e n c e as  t o t h e p r i c i n g methods o f IC 87-2. However,  considering  that  once  t h e taxpayer's  transfer  21 p r i c e s a r e not accepted by Revenue Canada, t h e taxpayer would, t o a v o i d double t a x a t i o n , use  the  have t o take t h e i s s u e t o t h e  mutual agreement procedure.  Courts  Most competent a u t h o r i t i e s  are a d o p t i n g p r i c i n g methods s i m i l a r t o those o f IC 87-2, can  or  and i t  be s a i d t h a t even i f t h e methods and c o n s i d e r a t i o n s endorsed  by Revenue Canada a r e not t o t a l l y a c c e p t a b l e t o t a x p a y e r s , i n the taxpayer's best i n t e r e s t ,  and t h e most p r a c t i c a l  i t is  solution  t o f o l l o w those p r i c i n g methods. In t h e f o l l o w i n g subchapters, methods  for calculating  various  types  of  the  I w i l l discuss  the  specific  arm's l e n g t h p r i c e i n r e l a t i o n t o  transactions:  the  transfer  of  goods,  the  p r o v i s i o n o f i n t r a - g r o u p s e r v i c e s and t h e t r a n s f e r o f technology. These d i s c u s s i o n s w i l l be based on IC 87-2, silent,  I w i l l refer  Regulation.  to  the  OECD  Report  and where IC 87-2 i s and  the  U.S.  IRC  22  SUBCHAPTER I - FOOTNOTES  1  Revenue Canada, I n t e r n a t i o n a l Transfer Pricing and o t h e r I n t e r n a t i o n a l T r a n s a c t i o n s , I n f o r m a t i o n C i r c u l a r 87-2(1987), at para. 5  2  Ibid, para. 6  3  Ibid, para. 6  4  N. Boidman, Canada-U.S. Intercompany (and other) T a x a t i o n I s s u e s , Report o f t h e Proceedings o f t h e T h i r t y - F i f t h Tax Conference. Canadian Tax Foundation (1983), a t 322  5  Supra. note 1, a t p a r a . 7  6  Supra. note 4, a t 322  7  (1962) D.T.C. 50  8  I b i d . 52  9  Supra. note 1, a t p a r a . 5  10  J . R. Robertson, A Revenue Canada P e r s p e c t i v e on I n t e r national Taxation: Transfer P r i c i n g and R e l a t e d I s s u e s , Report o f t h e Proceedings of the Thirty-Fourth Tax Conference. Canadian Tax Foundation (1882), a t 776  11  See g e n e r a l l y , G. T. Tamaki and R. W. Pound, Intercompany Pricing: In search of guidelines, 22 Canadian Tax J o u r n a l (1974), 460-471  12  T r a n s f e r P r i c i n g and M u l t i n a t i o n a l E n t e r p r i s e s . Report o f t h e OECD Committee on F i s c a l A f f a i r s (1979), a t p a r a . 11  13  I b i d , p a r a . 12  14  I b i d , p a r a . 17  15  Supra. note 1, a t p a r a . 15  16  Supra. note 12, a t p a r a . 19  17  Supra. note 4, a t 323  18  Supra. note 10, a t 777  19  Supra, note 12, a t p a r a . 20  23  20  Supra. note 12, a t p a r a . 21  21  Supra. note 12, a t p a r a . 22  22  The U.S.  IRC R e g u l a t i o n 1.482-l(d)(3)  23  The U.S.  IRC R e g u l a t i o n 1.482-l(d)(4)  24  Supra. note 12, a t p a r a . 15  25  Supra. note 1, a t p a r a . 12  24  SUBCHAPTER I I TRANSFER OF GOODS  Principle The arm's l e n g t h p r i n c i p l e i n i n t r a - g r o u p  transfer of  goods  i s t h a t p r i c e s p a i d f o r goods t r a n s f e r r e d between members o f MNCs should  be,  f o r t a x purposes,  those which have been p a i d  between  u n r e l a t e d p a r t i e s f o r t h e same o r s i m i l a r goods under t h e same o r similar circumstances. outright  transfer  1  of  (This p r i n c i p l e w i l l a l s o intangible  properties  apply  such  t o the  as patents,  2  m u t a t i s mutandis.)  1.  COMPARABLE UNCONTROLLED PRICE METHOD  Comparable u n c o n t r o l l e d p r i c e As t h e OECD Report and t h e U.S. provides  that  r e a s o n a b l e arm's price",  t h e primary length  IRC R e g u l a t i o n  do,  IC 87-2  method t o be a p p l i e d i s t o base t h e  price  on  a  "comparable  uncontrolled  i . e . t h e p r i c e i n comparable t r a n s a c t i o n s between a buyer 3  and a s e l l e r who a r e not r e l a t e d each other. "Uncontrolled"  transactions  can be d i v i d e d i n t o two types:  one i s a t r a n s a c t i o n between a member o f a MNC i n q u e s t i o n u n r e l a t e d p a r t y and,  t h e other  i s a t r a n s a c t i o n between 4  and an parties  which a r e n o t r e l a t e d t o each other o r t o t h e MNC. If a member o f a MNC which s o l d goods t o t h e other members  25  a l s o s o l d t h e same o r s i m i l a r goods t o  unrelated  the  the  same  or  similar  circumstances,  u n r e l a t e d p a r t i e s would be t h e arm's case,  this  comparable  and most p e r s u a s i v e estimate  length  price.  t o obtain  such  however,  evidence.  In  such  a  accurate  i n practice i t i s Even  i f an  t h e comparable u n c o n t r o l l e d  t o be comparable w i t h t h e i n t r a - g r o u p  i n every r e s p e c t  s e l l i n g p r i c e t o the  method and would r e s u l t i n t h e most  s i t u a t i o n e x i s t s per se. has  under  u n c o n t r o l l e d p r i c e method i s t h e e a s i e s t  o f t h e arm's l e n g t h p r i c e ,  almost i m p o s s i b l e  parties  ideal  transaction  t r a n s a c t i o n i n question  such as volumes o f s a l e o r a u x i l i a r y s e r v i c e s .  Comparabilitv To apply comparability First,  the  uncontrolled  price  should be observed c a r e f u l l y i n v a r i o u s the  i n the intra-group physically  comparable  t r a n s a c t i o n i n question.  identical,  mean  indicates,  that  they  differences  trademark,  tradename,  singularity i n quality, prices.  Accordingly  chemically because  such  aspects.  Where t h e goods  u n l e s s those goods a r e s t a n d a r d i z e d  are  comparable.  such  as  peculiarity design, i t  the  exclusive  differences.  5  are goods  i t does not OECD  patented  Report feature,  o f t h e package o r c o n t a i n e r ,  color,  might  As  happen  or  style  that  i d e n t i c a l p r o d u c t s a r e exchanged a t  of  the  goods should be t h e same as o r s i m i l a r t o those  such as n a t u r a l p r o d u c t s o r mass manufactured goods, always  method,  .  will  affect  physically different  and  prices .  Where t h e d i f f e r e n c e s e x i s t , i f  such d i f f e r e n c e s a r e capable o f q u a n t i f i c a t i o n on some reasonable basis,  i t i s s t i l l p o s s i b l e t o apply t h e comparable u n c o n t r o l l e d  p r i c e method. Second,  geographic markets should be comparable.  Where the  u n c o n t r o l l e d t r a n s a c t i o n took p l a c e i n a g e o g r a p h i c a l l y d i f f e r e n t market,  the  market  differences  in  has  to  economic  be  and  economically  social  comparable.  structure,  h a b i t s o r c o u n t r y ' s p o l i c i e s make the market p r i c e product  vary  from  c o u n t r y as w e l l . economically Report  one  country  Fortunately,  comparable,  states,  to  another,  o r commercial of  the  even  geographically  i n most cases, different  Third,  market l e v e l s should  one  market are  as  the  markets  OECD  can  s a t i s f a c t o r i l y compared o n l y i f the economic c o n d i t i o n s 7 same o r d i f f e r e n c e s can be e a s i l y  same  within  the Canadian and U.S.  however,  The  are  be the  eliminated. be comparable.  I t i s necessary  t o compare goods a t the same p o i n t i n the c h a i n from producers t o consumers. at  For example,  i f the i n t r a - g r o u p  the l e v e l of wholesale,  also  be  made  at  the u n c o n t r o l l e d  the l e v e l of wholesale.  different level i s available, uncontrolled differences  transaction  made should  Where o n l y data a t a  i n order t o apply  p r i c e method i t has easily.  t r a n s a c t i o n was  the  comparable  t o be p o s s i b l e t o q u a n t i f y  such  Q  9 In the r e c e n t  Indalex l i m i t e d v. Her MaTesty The  Queen,  Court used the comparable u n c o n t r o l l e d p r i c e method t o the  reasonableness  of  pricing  between  the  determine  taxpayer  and i t s  r e l a t e d company i n Bermuda from which the taxpayer purchased aluminum  billet.  the  the  Since v a l i d comparable s a l e s between u n r e l a t e d  p a r t i e s were not a v a i l a b l e ,  the Court compared a s a l e  by  Alcan  (the o r i g i n a l s u p p l i e r o f aluminum b i l l e t t o the Bermuda company)  27  to  the  Bermuda  company  as t h e c l o s e s t arm's l e n g t h  comparable  w i t h t h e s a l e by t h e Bermuda company t o t h e t a x p a y e r . found  that the a d d i t i o n a l discounts  were o b t a i n e d  by t h e Bermuda  company over what t h e taxpayer c o u l d have n e g o t i a t e d with two  Alcan.  Then  I t was  1 0  on  i t s own  t h e Court made t h e adjustment t o equate these  t r a n s a c t i o n s by r e d u c i n g  t h e amount f o r such  extra  benefits  t h a t t h e t a x p a y e r r e c e i v e d by p u r c h a s i n g from i t s Bermuda company from t h e comparable p r i c e . In a d d i t i o n ,  1 1  t h e volume o f s a l e s ,  time p e r i o d d u r i n g which  the t r a n s a c t i o n took p l a c e and other c o n d i t i o n s  of  should  such d i f f e r e n c e s  should  be  comparable.  I f differences exist,  a l s o be e a s i l y a d j u s t a b l e .  "package  deal",  auxiliary  i n intra-group  services  properties  to  are often  account those  t h e buyer included.  Furthermore, sales or  by  as s t a t e d  MNCs,  transfer  transactions  in a  provision of of  intangible  I t i s necessary t o take i n t o  possibilities.  Pirate price In c o n n e c t i o n  with the comparability  treatment o f a " p i r a t e differences  of  opinion  price"  presents  between  o f goods concerned, t h e a  t h e OECD  problem. Report  There  are  and Revenue  Canada. On t h e one hand, t h e OECD Report s t a t e s : Although t h e p r i c e s a t which they a r e s o l d may g i v e an i n d i c a t i o n o f t h e mere c o s t of production of the p a t e n t e d goods they c o u l d h a r d l y be r e l e v a n t f o r any other purpose as they do n o t take i n t o account r e s e a r c h and development, technical assistance and other connected s e r v i c e s . 12  28  Revenue determine  the  Based on  believes,  from  Revenue Canada  may  on  the  other  "mere" c o s t o f p r o d u c t i o n  experience  industry, price"  Canada  be  quite  studies  of  hand,  "to  i s extremely r e l e v a n t " . Canadian  pharmaceutical  f e e l s t h a t "the r e f e r e n c e  reasonable  that  i n the  to a "pirate  circumstances  for  13 e v a l u a t i o n o f non-arm's l e n g t h Considering information,  difficulties  imports". i n obtaining  the  foreign-based  a p i r a t e p r i c e might h e l p t h e t a x o f f i c i a l  i n d i c a t i o n of the production  as an  cost i n p r a c t i c e .  Isolated transaction In c o n n e c t i o n it  should  with the comparability  o f t h e volume o f s a l e s ,  be noted t h a t some MNCs might make an i s o l a t e d ( o f t e n ,  small-scaled)  transaction  with  unrelated  parties  at  an  u n r e a l i s t i c p r i c e on purpose t o j u s t i f y t h e i r t r a n s f e r p r i c e s . At  t h e same time,  t a x a u t h o r i t i e s a l s o should  an i s o l a t e d t r a n s a c t i o n , purpose,  as  H o f e r t case, selling  whether o r  n o t t h e MNC  n o t use such made  t h e comparable  uncontrolled  transaction.  Revenue  made  adjustments  price  of  Canada  Christmas  upward  trees  on  the  selling  p r i c e i n t h e Canadian market.  h e l d t h a t s i n c e t h e volume o f s a l e s i n t h e domestic only  one-ninth  of  t h e U.S.  sales  and  there  d i f f e r e n c e s i n terms and c o n d i t i o n s between those sales,  In t h e on t h e  by t h e taxpayer t o t h e U.S.  company w i t h which t h e taxpayer was not d e a l i n g a t arm's based  i t on  length, The Court  market were  two  was  various types  of  Revenue Canada's assessment was an " u n r e a l i s t i c approach"  and  a l l o w e d t h e taxpayer's  appeal.  Problems o f t h e comparable u n c o n t r o l l e d p r i c e method Since s t r i c t comparability very  difficult,  uncontrolled  sometimes  price  i s required  impossible  method.  There  a v a i l a b l e i n Canada, b u t a c c o r d i n g Accounting  Office,  adjustment  cases  t h e IRS  to  apply  i s no  i t  is  t h e comparable  statistical  data  t o surveys by t h e U.S. General  o n l y 3 percent by  i n practice  of the t o t a l transfer p r i c i n g  were  based  on  t h e comparable  15 uncontrolled  price  method.  Such  a  percentage i n d i c a t e s t h e  d i f f i c u l t i e s i n a c t u a l a p p l i c a t i o n o f t h i s method. I t o f t e n happens t h a t i n i n t r a - g r o u p the  goods  a r e so  transactions  o f MNCs  s p e c i a l i z e d o r unique t h a t the MNC would not  s e l l them t o u n r e l a t e d p a r t i e s , o r t h a t i n h i g h l y i n t e g r a t e d MNCs goods are p r o c e s s e d e n t i r e l y w i t h i n a group users.  In  ultimate  end  such cases where s e m i - f i n i s h e d p r o d u c t s o r components  are i n q u e s t i o n ,  t h e a p p l i c a t i o n o f t h e comparable  p r i c e method i s i m p o s s i b l e .  2.  until  uncontrolled  1 6  RESALE PRICE METHOD  Secondary methods Where  t h e "comparable u n c o n t r o l l e d p r i c e " i s n o t a v a i l a b l e ,  IC 87-2 recommends t h e " r e s a l e  price"  method  and  "cost  plus"  17 method as secondary methods. The  resale  p r i c e method s t a r t s w i t h t h e taxpayer's  selling  30  price  of  the  goods,  which  have been purchased from a r e l a t e d  s e l l e r , t o an arm's l e n g t h customer and reduces t h e s e l l i n g p r i c e by an a p p r o p r i a t e mark-up which which  the  profit.  reseller  would  represents  seek  to  the  amount  out  of  cover h i s c o s t s and make a  1 8  Recommended use T h i s method i s thought t o be most u s e f u l where i t i s a p p l i e d 19 t o marketing o p e r a t i o n s ,  more s p e c i f i c a l l y ,  does  the  not  add  processing, selling  value  to  and t h e  operation.  taxpayer If  goods o r i n c o r p o r a t e identity  of  the  goods  the  into  are  o r does not do any f u r t h e r carrying  taxpayer  more  where t h e taxpayer  out  marketing  or  does f u r t h e r p r o c e s s i n g t o  complicated  products  so  that  goods i s l o s t o r transformed,  i t would become 20 v e r y d i f f i c u l t t o c a l c u l a t e an a p p r o p r i a t e mark-up. An a p p r o p r i a t e mark-up An  appropriate  mark-up  can  be c a l c u l a t e d by r e f e r e n c e t o  gross p r o f i t mark-up ( u s u a l l y expressed earned  by  t h e taxpayer  purchased t h e goods, the  non-arm's  which i s s i m i l a r t o t h e goods  length  is  transaction,  not a v a i l a b l e ,  u n c o n t r o l l e d p a r t i e s may caution.  of  sales)  on t h e t r a n s a c t i o n i n which t h e taxpayer  resold to unrelated parties. mark-up  as percentage  In  a  from case  involved  in  u n r e l a t e d p a r t i e s and where  such  a  profit  t h e p r o f i t mark-up earned by t o t a l l y  serve  as  a  guide  with  considerable  2 1  Here again,  t h e c o m p a r a b i l i t y p r e s e n t s t h e problem.  As the  31 OECD Report s t a t e s , whereas t h e comparable u n c o n t r o l l e d p r i c e method calls for t h e use o f comparable p r i c e , t h e r e s a l e p r i c e method c a l l s i n e f f e c t f o r t h e use o f comparable markups. 22 It  can be s a i d t h a t whichever  method  is  adopted,  we  are  running i n t h e same c i r c l e . For  mark-ups  to  be comparable,  i t i s important t h a t the  f u n c t i o n s performed and t h e r i s k s taken by t h e r e s e l l e r s i n arm's l e n g t h t r a n s a c t i o n s should be t h e same as o r s i m i l a r t o those  in  23 non-arm's l e n g t h t r a n s a c t i o n s . indicates,  profit  mark-up  he has t o make l i t t l e o r no e f f o r t s ,  should  be  small.  On  r e s e l l e r t a k e s on t h e f u l l r i s k o f ownership full  responsibility  marketing, stocks  as t h e OECD Report  i f t h e r e s e l l e r e f f e c t i v e l y performs minimal s e r v i c e s  as a f o r w a r d i n g agent, i . e . his  F o r example,  other  connecting  t r a n s p o r t , h i s mark-up should Therefore,  together  Revenue  services  the such  will  carried  out.  Where reseller, adjustable,  the  financing  packaging 24  or  be s u b s t a n t i a l l y h i g h .  Canada  i d e n t i f y and e v a l u a t e  or product l i n e ,  with  goods, as  strongly  recommends  thorough f u n c t i o n a l a n a l y s i s o f a c t i v i t i e s o f which  i f the  f o r and t h e r i s k s i n v o l v e d i n a d v e r t i z i n g ,  d i s t r i b u t i n g and g u a r a n t e e i n g  and  the contrary  members  that of  with respect t o a given  t h e r o l e and c o n t r i b u t i o n o f  each  a  MNCs,  product  member,  be  2 5  there unless the  are  d i f f e r e n c e s i n f u n c t i o n s performed by the  such mark-up  differences in  the  are  non-arm's  quantifiable length  and  transaction  cannot be a comparable mark-up. As t o t h e s i m i l a r i t y o f goods, placed  on  the  comparability  since  in  primary  emphasis  f u n c t i o n s and a l a c k o f c l o s e  s i n g u l a r i t y o f goods i s n o t n e c e s s a r i l y i n d i c a t i v e o f mark-up  percentages,  is  dissimilar  such c l o s e p h y s i c a l s i m i l a r i t y o f goods as  under t h e comparable u n c o n t r o l l e d p r i c e method  i s not  required  27 under t h i s method. Whether  or  r e s e l l t h e goods, trademarks  used  not  the  reseller  has  the exclusive r i g h t to  t h e e f f e c t o f any i n t a n g i b l e p r o p e r t y by  t h e r e s e l l e r and t h e g e o g r a p h i c a l  such  as  market i n  which t h e t r a n s a c t i o n s took p l a c e should be taken i n t o account. In  addition,  the  resale  should take p l a c e w i t h i n a s h o r t  time b e f o r e o r a f t e r t h e time o f t h e c o n t r o l l e d s a l e . Summing up As s t a t e d b e f o r e ,  where t h e goods  i n question  are  semi-  f i n i s h e d p r o d u c t s o r one o f many p a r t s o f a l a r g e r u n i t , o r where significant impossible  processing  has  been  done  to  the  goods,  t o apply t h e r e s a l e p r i c e method.  Although Revenue Canada and t h e OECD Report do p a r t i c u l a r preference plus price  method, method  evaluations. accurate  i t is  f o r the resale p r i c e  method  IRC R e g u l a t i o n ,  involves  easier  Accordingly  28  or  a c c o r d i n g t o t h e U.S. fewer  and  i t i s likely  to  have  the  result than  a  cost  the resale  computations  r e p r e s e n t a t i o n o f an arm's l e n g t h p r i c e  plus method.  not  and  i n a more the  cost  3.  COST PLUS METHOD  Recommended use In the c o s t p l u s method, transferor's  cost  of  the c a l c u l a t i o n  goods  and  then  starts  i s added an  with  the  appropriate  29  mark-up. The  a p p l i c a t i o n o f t h i s method would be most u s e f u l  in  the  f o l l o w i n g s i t u a t i o n s where: (a) S e m i - f i n i s h e d  products  which r e q u i r e s i g n i f i c a n t p r o c e s s i n g 30 are s o l d between r e l a t e d p a r t i e s ; (b) D i f f e r e n t e n t i t i e s of a MNC have concluded joint facility 31 agreements or l o n g term buy-and-supply arrangements; (c) The s u b s i d i a r y e s s e n t i a l l y performs a r o l e o f s u b c o n t r a c t o r 32 and goods s o l d are nominal p a r t s o f a l a r g e r u n i t ; (d) The goods  are  specialized  product  tailored  to  suit  the  33 i n d i v i d u a l customer; (e) There are a few major c o s t components i n v o l v e d . However, t h i s method c o n t a i n s two major problems;  assessing  c o s t and an a p p r o p r i a t e mark-up. Cost While  cost  accounting  concepts  are not u n i v e r s a l and  vary  34 from country t o country and  from b u s i n e s s t o b u s i n e s s ,  IC  r e q u i r e s the c o s t be computed in accordance with generally accepted accounting p r i n c i p l e s or normal commercial a c c o u n t i n g p r a c t i c e s i n the i n d u s t r y i n Canada. 35  87-2  34  If and  t h e c o s t accounting  appropriate  method o f t h e taxpayer a r e s u i t a b l e  and used c o n s i s t e n t l y by  t h e taxpayer,  Revenue  36 Canada would accept i t . include  a  number  Where t h e c o s t o f t h e p a r t i c u l a r  o f c o s t components o r c o s t s which v a r y over a  p e r i o d such as c o s t s o f i n p u t o f m a t e r i a l s o r l a b o r , t h a t i n MNCs  goods  considering  v a r i o u s types o f p r o d u c t s a r e b e i n g manufactured i n  the same f a c i l i t y  and  at  t h e same  time  and  t h e volume  of  a c t i v i t i e s f l u c t u a t e s , i n p r a c t i c e , as t h e OECD Report suggests, it may o f t e n be necessary t o accept some a v e r a g i n g o f the c o s t i n c u r r e d over a p e r i o d o f time, over a group of products, over a p a r t i c u l a r l i n e o f p r o d u c t i o n . 37 In a d d i t i o n , t h e OECD Report a l s o i n d i c a t e s , t h i s method has a tendency " t o over-emphasize h i s t o r i c a l  costs,  ignore  demands 38  and  f a i l s t o r e f l e c t competitive Where  such  costs  as  capital  campaigns a r e t o be a l l o c a t e d allocation  of  such  costs  conditions  expenditure  between  would 39  adequately."  members  require  or advertising of  a  complicated  MNC,  the  work and  thorough f u n c t i o n a l a n a l y s i s . An a p p r o p r i a t e mark-up An  appropriate  mark-up can be c a l c u l a t e d by r e f e r e n c e  t o the  the g r o s s p r o f i t percentage ( u s u a l l y expressed as a percentage o f cost) earned by t h e taxpayer on t a x p a y e r s o l d t h e goods,  the transaction  a  the  which a r e s i m i l a r t o t h e goods i n v o l v e d  i n t h e non-arm's l e n g t h t r a n s a c t i o n , such  i n which  to  unrelated  comparable t r a n s a c t i o n i s n o t a v a i l a b l e ,  parties. I f an a p p r o p r i a t e  35  mark-up can be c a l c u l a t e d by which the  the unrelated goods  reference  to  the  person s o l d the goods,  involved  in  the  non-arm's  transaction  in  which are s i m i l a r t o  length transaction,  to  40 unrelated  parties.  The  comparability  also  becomes  a key c o n s i d e r a t i o n  under  t h i s method. As under the r e s a l e p r i c e method, performed should  by t h e s e l l e r 41  be  analyzed.  e f f e c t o f any geographical  a c t u a l economic  (taxpayer) and o t h e r e n t i t i e s o f the MNC The s i m i l a r i t y o f the type o f goods,  intangible markets  property  should  also  used  by  price  the  reseller  be taken i n t o account.  c l o s e p h y s i c a l s i m i l a r i t y o f t h e goods as uncontrolled  functions  under  the  the and Such  comparable  method i s not r e q u i r e d under t h i s method f o r 42  the same reason mentioned i n the r e s a l e p r i c e method. Cost a c c o u n t i n g methods a l s o should be c o n s i d e r e d . appropriate  mark-up  S i n c e an  w i l l v a r y w i t h t h e c o s t i n g method.  IC 87-2  states: I f the cost includes only d i r e c t production costs, an appropriate mark-up would be an amount t h a t i s sufficient t o cover normal i n d i r e c t overhead and general and a d m i n i s t r a t i v e expenses p l u s a reasonable profit contribution, whereas i f a full absorption c o s t i n g method i s used, a lower mark-up would be i n d i c a t e d . 43 Therefore, transaction  is  where not  the  costing  available,  the  data  of  the  comparable  a p p l i c a t i o n o f t h i s method  becomes d i f f i c u l t . Where t h e r e a r e d i f f e r e n c e s between  the  comparable  in  transaction  the from  above-mentioned which an  items  appropriate  36  mark-up would be d e r i v e d and t h e the  mark-up  must be a d j u s t e d  d i f f e r e n c e s should  non-arm's  length  transaction,  t o r e f l e c t such d i f f e r e n c e s .  be those which have a d e f i n i t e and  Such  reasonably  44  a s c e r t a i n a b l e e f f e c t on p r i c e .  Summing up Considering obtain.the details  that  in  c o s t i n g data  of  costing  practice  of  data  t r a n s a c t i o n i n question  i t is  comparable of  the  often impossible to  transactions  (even  taxpayer w i t h r e s p e c t t o the  a r e o f t e n not a v a i l a b l e ) ,  t h i s cost  method would be u s e f u l i n s p e c i f i c , l i m i t e d s i t u a t i o n s . it  may  also  be  useful  as  a  the  means  to  plus  However,  verify provisionally 45  acceptable 4.  p r i c e s a f t e r other methods have been a p p l i e d .  OTHER METHODS AND GENERAL CONSIDERATIONS  " F o r t h " method Where available employed  none or to  of  t h e above-mentioned b a s i c t h r e e methods are  reasonable calculate  to the  apply, arm's  other length  methods may a l s o be necessary t o support o r 46  methods price. to  should  be  Such " f o r t h "  cross-check  the  p r i c e d e r i v e d by t h e b a s i c t h r e e methods. IC  87-2 p r o v i d e s  o n l y one example o f t h e other methods as a  v e r i f y i n g measure o f t h e proposed p r i c e . f o l l o w i n g check-points; production",  "value  as  This  method  "cost of d i r e c t materials", a  replacement  part"  and  uses  the  " f u l l cost of "value  as a  f r a c t i o n o f t h e market v a l u e o f t h e whole Since  IC  exhaustive,  87-2  does  not  intend  i t i s expected t h a t ,  product". that  this  example  is  i n a c t u a l assessments, Revenue  Canada would and should use other methods such as t h e OECD Report recommends.  Comparable p r o f i t method ( i n d u s t r y average method) T h i s method compares t h e taxpayer's the  g r o s s p r o f i t o f a p a r t i c u l a r product  s i m i l a r c o r p o r a t i o n s i n t h e same that of the industry's average. The  or  overall  performance  or  l i n e w i t h t h a t o f other  similar  circumstances,  or  4 8  OECD r e p o r t s t a t e s :  L e v e l s o f p r o f i t i n an i n d u s t r y may f o r example conform to a p a t t e r n and an e x c e p t i o n t o t h e p a t t e r n might i n d i c a t e t h a t p r o f i t s were b e i n g s h i f t e d by a r t i f i c i a l t r a n s f e r p r i c e s . 49 However,  t h e Report  continues  that exceptional p r o f i t s or  l o s s e s do n o t n e c e s s a r i l y mean t h e r e s u l t o f a r t i f i c i a l pricing  and t h e taxpayer  transfer  could provide a l o g i c a l explanation f o r  50 the d i s c r e p a n c y .  Therefore,  comparison  should  be  made  with  c a r e , and i n p r a t i c e t h i s method would be u s e f u l o n l y as p o i n t e r s 51 for  further investigation.  P r o f i t a l l o c a t i o n method ( " g l o b a l According  w  approach method)  t o t h e OECD Report, t h i s method i s  t o a l l o c a t e some p r o p o r t i o n o f t h e combined n e t income arising from a s a l e s t r a n s a c t i o n t o t h e v a r i o u s a s s o c i a t e d c o r p o r a t i o n s concerned i n i t on t h e b a s i s o f  38  t h e i r proportionate  c o n t r i b u t i o n t o the f i n a l p r o f i t .  Such b a s i s f o r c o n t r i b u t i o n c o u l d be the r a t i o of sale  of  one  entity  to  total  sales  of  a  respective  MNC,  m a n u f a c t u r i n g c o s t t o t o t a l manufacturing c o s t ,  52  respective  respective  labor 53  f o r c e s t o t o t a l l a b o r f o r c e s , o r combination o f s e v e r a l  ratios.  A world-famous " u n i t a r y t a x " system i n the S t a t e o f C a l i f o r n i a i s based on the formula u s i n g  the  ratios  of  sales,  payroll  and  assets. T h i s method has  been c r i t i c i z e d by the OECD, t a x a u t h o r i t i e s  and MNCs f o r a number o f reasons: (a) T h i s method would n e c e s s a r i l y be a r b i t r a r y and an a l l o c a t i o n < 54 of p r o f i t s may bear no sound r e l a t i o n s h i p t o the economic f a c t s ; (b) To reduce such an a r b i t r a r i n e s s of the r e s u l t s to a negligible  degree  would  necessitate  a  complex  functional  information  about t o t a l  55 analysis; (c) T h i s method r e q u i r e s f u l l of the whole MNC,  but such i n f o r m a t i o n might not be a v a i l a b l e f o r  the t a x a u t h o r i t i e s and trative  burden  information;  activities  i t would impose  an i n t o l e r a b l e  adminis-  on the taxpayers t o r e q u i r e them t o p r o v i d e  such  5 6  (d) From the v i e w p o i n t of tax a u t h o r i t i e s ,  t h i s method does not  e f f e c t i v e l y h i g h l i g h t double-charging,  does not ensure t h a t 57  and  the t a x a u t h o r i t y r e c e i v e a f a i r share of t a x haven p r o f i t s ; (e) U n l e s s the s p e c i f i c g l o b a l method i s accepted by the  relevant  countries,  i t would r e s u l t i n double  in  impossible  t h a t a l l c o u n t r i e s concerned c o u l d agree on a formula  taxaion.  It  is  fact  39 that  could  be  applied  d i f f e r e n t accounting Therefore,  under  their  respective  t a x law and  methods.  t h e OECD Report d i d n o t recommend t h i s method and  Revenue Canada has a l s o been r e l u c t a n t t o adopt i t . However, practice,  t h i s method might be a c c e p t a b l e  o t h e r methods cause s e r i o u s d i f f i c u l t i e s authorities  as a l a s t r e s o r t where and  the relevant  a r e a b l e t o adopt a common approach,  i n f o r m a t i o n c o u l d be a v a i l a b l e ,  in  tax  and necessary  o r u s e f u l as a measure t o  check  59  the assessment u s i n g o t h e r methods.  Net y i e l d e x p e c t a t i o n  ( r e t u r n on investment) method  T h i s method i s t o compare t h e y i e l d o r r e t u r n on t h e c a p i t a l invested  i n t h e taxpayer i n q u e s t i o n w i t h t h e y i e l d o r r e t u r n on  the c a p i t a l i n v e s t e d  i n corporations,  similar  or  activities  investment.  requiring  which  are carrying  t h e same  kind  capital  6 0  Another a l t e r n a t i v e i s t o compare t h e r e t u r n by  of  on  t h e taxpayer  on  investment  i n q u e s t i o n w i t h t h e r e t u r n which t h e taxpayer  c o u l d g e t from i n v e s t i n g t h e c a p i t a l i n o t h e r T h i s method a l s o p r e s e n t s  difficulties.  ways.  61  To apply t h e  first  approach, t h e f i n a n c i a l s t r u c t u r i n g o f t h e comparable c o r p o r a t i o n should  be  e s s e n t i a l l y s i m i l a r t o t h a t o f t h e taxpayer.  the d i f f i c u l t adjustments should be made t o order t o ensure t h e c o m p a r a b i l i t y .  62  I f not,  the c a l c u l a t i o n i n  The second  approach  i s so  63  a r b i t r a r y and i m p r e c i s e t h a t i t cannot be used i n i s o l a t i o n . However, t h i s method might be u s e f u l i n some cases as an i n d i c a t i o n o f a reasonable  range o f p o s s i b l e p r o f i t margins.  64  40  The o r d e r o f p r i o r i t y i n a p p l i c a t i o n o f methods The methods  U.S.  IRC  should  be  applied  i n the order  price  method,  resale  uncontrolled method.  Regulation  provides  the b a s i c three  of  price  t h e comparable  method and c o s t p l u s  65  According t o the regulation, price  that  method  would  result  t h e comparable u n c o n t r o l l e d  i n t h e most a c c u r a t e e s t i m a t e o f an  arm's l e n g t h p r i c e , and as s t a t e d b e f o r e , t h e r e s a l e p r i c e method would r e s u l t i n t h e next most a c c u r a t e e s t i m a t e that  t h e arm's  length  price  On  the other  hand,  reason  under t h e r e s a l e p r i c e method i s  "based more d i r e c t l y upon a c t u a l arm's l e n g t h under t h e c o s t p l u s m e t h o d . "  f o r the  transactions  than  66  t h e OECD  Report  and Revenue Canada,  although they t r e a t t h e comparable u n c o n t r o l l e d p r i c e method as a primary method, method  whereas t h e r e s a l e p r i c e method  as secondary  methods,  and  cost  plus  do n o t p r o v i d e t h e s t r i c t o r d e r o f  priority. Considering that the s t r i c t preference U.S.  of  t h e comparable  Regulation,  might  have  make s u b j e c t i v e approximation approach  of  order  t h e OECD  of  priority,  i.e.  the  u n c o n t r o l l e d p r i c e method by t h e e n f o r c e d t h e IRS f i e l d a u d i t o r t o  of  t h e arm's  Report  and  this  issue,  the  Canadian  length  Revenue  price,  Canada  would  the be  preferable. In  connection  misunderstandings  with among  there  seem  taxpayers  to  be some  and  tax  p r a c t i t i o n e r s as t o Revenue Canada's p o l i c y , t h a t i s , whether t h e  41 " f o r t h " method may be accepted by Revenue Canada where one o f the 67  basic  three  the U.S.  methods  i s a l s o a p p l i c a b l e and r e a s o n a b l e .  IRC r e g u l a t i o n p r o v i d e s t h a t where  one  of  While  the  basic  t h r e e methods i s a p p l i c a b l e , such method must be u t i l i z e d u n l e s s t h e taxpayer can e s t a b l i s h t h a t , c o n s i d e r i n g a l l t h e f a c t s and circumstances, some method o t h e r than t h e t h r e e methods i s c l e a r l y more a p p l i c a b l e . 68 On  the  other  p o l i c y i n IC 87-2.  hand,  Revenue  Therefore,  Canada  does not s t a t e t h e i r  taxpayers and  tax  are a f r a i d t h a t Revenue Canada might i n t e n d t o ,  practitioners  i n fact,  enforce  t h e taxpayer t o use t h e t h r e e methods i n any case. However, method,  s i n c e t h e Canadian taxpayer can  providing  that  use  any  pricing  i t r e s u l t s i n a reasonable arm's l e n g t h  p r i c e , under t h e Income Tax A c t , and j u d g i n g from a c t u a l t r a n s f e r p r i c i n g cases which were Canada and t a x p a y e r s , order  of  priority  successfully  settled  between  Revenue  i t seems t h a t r e g a r d l e s s o f t h e recommended of  IC  87-2,  t h e f i e l d a u d i t o r s o f Revenue  Canada might be allowed t o use t h e method which p r o v i d e s t h e most a p p r o p r i a t e evidence words,  i n the p a r t i c u l a r  circumstances.  In  other  t h a t Revenue Canada has t h e same p o l i c y i n t h i s matter as  the IRS i n i t s a c t u a l enforcement.  C o n f i d e n t i a l i t y o f the t h i r d party To c a l c u l a t e arm's l e n g t h p r i c e s ,  e s p e c i a l l y where  one  of  the t h r e e methods i s a p p l i e d , i n f o r m a t i o n on comparable p r i c e s o r mark-up from t h e t h i r d p a r t i e s i s i n d i s p e n s a b l e .  42 However,  where  Revenue  Canada  obtained  information  on  comparable t r a n s a c t i o n s from t h e t h i r d p a r t i e s , s u b s e c t i o n 241(1) of  t h e Income Tax A c t p r o h i b i t s Revenue  such  information  to  t h e taxpayer  Canada  from  i n question;  p e r m i s s i o n t o d i s c l o s e t h e i n f o r m a t i o n i s granted parties,  unless by  the  the third  Revenue Canada has t o w a i t u n t i l l e g a l proceedings  commenced w i t h r e s p e c t t o t h e assessment i s s u e d . u n t i l t h e taxpayer of  disclosing  Canada.(Subsection 241(3) o f t h e I T A )  assessment.  I n o t h e r words,  has f i l e d a N o t i c e o f Claim w i t h t h e Tax Court  Canada o r t h e Statement o f Claim w i t h  This rule  have  often  causes  the  Federal  Court  of  6 9  serious  problems  i n the actual  Where t h e a u d i t o r d i s c u s s e s w i t h t h e taxpayer  on h i s  proposed arm's l e n g t h p r i c e , he cannot p r o v i d e any d e t a i l s o f t h e comparables taxpayer  used  i n the c a l c u l a t i o n  would  t o deduce t h e i d e n t i t y o f t h e comparables.  i n a p a r t i c u l a r case, and  which  persuade  Accordingly,  t h e a u d i t o r might be f o r c e d  as t o t h e reasonableness  enable t h e  to  negotiate  o f h i s assessment  showing i t s b a s i s and i t would make t h e procedure  without  time-consuming  and cause unnecessary arguments o r t a x l i t i g a t i o n s .  Custom d u t i e s The d i f f e r e n c e i n approach between income t a x a d m i n i s t r a t i o n and  custom  administration  situation.  F o r example,  particular  intra-group  custom a d m i n i s t r a t i o n , an  arm's  length  price  sometimes made MNCs f a c e a d i f f i c u l t  where t h e p r i c e f o r imported transaction  goods i n a  by a MNC i s accepted by t h e  i f such t r a n s f e r p r i c e i s n o t accepted as f o r income  t a x purposes  by  the tax  43  a u t h o r i t y , t h e MNC has t o s u f f e r t h e adjustment,  v i c e versa.  In  other words, MNCs have t o f i x t h e i r t r a n s f e r p r i c e s t o conform t o various  conflicting  requirements  by  d i f f e r e n t administrations  70 w i t h i n t h e same country. Therefore should  i t has been suggested t h a t income t a x a u t h o r i t i e s  accept  the 71  value  f o r custom  duties  established  for  imported goods. However, as t h e OECD Report suggests, since custom and income t a x a d m i n i s t r a t i o n a r e not always l o o k i n g a t 72 the  same  sort of transfers,  made i n t h e same context difference  i . e . , v a l u a t i o n o f goods a r e not  by t h e r e s p e c t i v e  i s i n e v i t a b l e and i t i s not a p p r o p r i a t e  income t a x a u t h o r i t i e s t o accept t h e v a l u e all  administration,  such  t o o b l i g e the  f o r custom  duties  in  cases. Although most o f custom l e g i s l a t i o n  applying  the  or  administration  arm's l e n g t h p r i n c i p l e which i s e q u i v a l e n t  are  t o that  73 o f income t a x duties  might  acceptable  and a c c o r d i n g l y , be  similar  to  i n p r a t i c e , the value the  for tax authorities,  transfer  prices  f o r custom which  Revenue Canada c l e a r l y s t a t e s i n  IC 87-2 t h a t the Department i s under no o b i l i g a t i o n t o accept t h e e s t a b l i s h e d o r r e p o r t e d v a l u e f o r duty when c o n s i d e r i n g the income t a x i m p l i c a t i o n o f a non-arm's length i m p o r t a t i o n . 74  S a f e haven The  OECD Report s t a t e s ,  it  may  be  helpful  to  are  consider  whether  limits  of  44  tolerance c o u l d be formulated i n advance by t a x a u t h o r i t i e s and made known t o e n t e r p r i s e s by what a r e sometimes known as s a f e haven r u l e s , i n d i c a t i n g t h a t price falling w i t h i n c e r t a i n ranges would be accepted without q u e s t i o n . 7 5 Such  s a f e haven r u l e s might be u s e f u l f o r taxpayers as w e l l  as t a x a u t h o r i t i e s i n t h e v a r i o u s  aspects.  However, t h i s approach p r e s e n t s First, fit  safe  several  difficulties:  haven r u l e s tend t o be a r b i t r a r y and would not  i n a l l cases even  within  t h e same  industry  and  tend  to  76 o b s o l e t e as b u s i n e s s  c o n d i t i o n s change.  Second, i t would be d i f f i c u l t t o minimize such a r b i t r a r i n e s s and obsolescence, .  and would need c o n s i d e r a b l e  .  and continuous work  77  by t a x a u t h o r i t i e s . Third, i t would a l s o be d i f f i c u l t t o f i x a s a f e haven range 78 of p r i c e s which i s a c c e p t a b l e t o a number o f c o u n t r i e s . Fourth,  s a f e haven ranges would a f f e c t t h e p r i c e s  i n the  79  open market. Fifth, avoidance.  this  might  provide  an  avenue  f o r tax  8 0  Therefore, haven  approach  rule  t h e OECD Report does  and  Revenue  n o t recommend  this  safe  Canada does not express any i d e a i n IC  87-2. On t h e o t h e r hand, the U.S. IRC R e g u l a t i o n interest rates; i n intra-group prescribed  i n t h e area o f i n t r a - g r o u p  l o a n o f MNCs,  adopted s a f e haven r u l e s f o r arm's l e n g t h  t h a t i s , i f t h e p a r t i c u l a r i n t e r e s t r a t e charged loan  or  advance,  i n the regulation,  which  meets  the  conditions  f a l l s w i t h i n t h e range p r e s c r i b e d  45  i n the r e g u l a t i o n , the i n t e r e s t r a t e i n q u e s t i o n w i l l be  accepted  81 by the IRS. provides  In a s i m i l a r  the  the  Canadian  Income  Tax  Act  r u l e t h a t i n a non-arm's l e n g t h l o a n by a Canadian  corporation to reasonable  way,  a  in  the  lender  person  without  interest  at  a  be deemed t o have r e c e i v e d 82 i n t e r e s t computed a t a p r e s c r i b e d r a t e . (Since such prescribed 83  rates  rate,  non-resident  shall  the Income Tax R e g u l a t i o n  o f i n t e r e s t but  a single rate,  i s not p r o v i d e d  i t might not be  as a range  called  a  "safe  haven range".) I t should whether  it  be noted t h a t Revenue Canada has  might  been  be p o s s i b l e t o develop standard  g u i d e l i n e s f o r Canada and u s i n g them i n s p e c i f i c For example, Revenue Canada does not q u e s t i o n  considering international  circumstances.  8 4  r o y a l t i e s of 6 p e r -  cent or l e s s on p a t e n t e d phamaceutical p r o d u c t s i n a u d i t of  that  85 industry.  And  i t can be expected t h a t through the j o i n t  study w i t h the IRS,  industry  Revenue Canada would i n c r e a s e s p e c i f i c areas  i n which s a f e haven r u l e s c o u l d be used.  46  SUBCHAPTER I I  -  FOOTNOTES  1  T r a n s f e r P r i c i n g and M u l t i n a t i o n a l E n t e r p r i s e s . Report o f the OECD Committee on F i s c a l A f f a i r s (1979), a t p a r a . 37  2  Revenue Canada, I n t e r n a t i o n a l Transfer Pricing and Other I n t e r n a t i o n a l T r a n s a c t i o n s , I n f o r m a t i o n C i r c u l a r 87-2 (1987), a t p a r a . 13  3  I b i d . p a r a . 13  4  Supra. note 1, a t para. 48  5  Supra. note 1, a t p a r a . 52  6  Supra, note 2, a t p a r a . 14  7  Supra. note 1, a t p a r a . 49  8  Supra. note 1, a t p a r a . 50  9  (1986) D.T.C » • 6039  10  I b i d . 6048  11  I b i d . 6051  12  Supra. note 1, a t p a r a . 52  13  J . R. Robertson, A Revenue Canada P e r s p e c t i v e on International Taxation: Transfer P r i c i n g and R e l a t e d Issues, Report o f t h e Proceedings of the Thirty-Fourth Tax Conference. Canadian Tax Foundation (1982) , a t 778  14  (1962) D.T.C. 52  15  IRS Could B e t t e r P r o t e c t U.S. Tax I n t e r e s t i n Determining the Income o f M u l t i n a t i o n a l C o r p o r a t i o n s , Report t o the Chairman of t h e House Committee on Ways and Means, t h e U.S. General A c c o u n t i n g O f f i c e (1981), a t 27  16  Supra, note 1, a t p a r a . 38  17  Supra. note 2, a t p a r a . 16  18  Supra. note 1, a t p a r a . 56  19  Supra. note 1, a t p a r a . 56  20  Supra , note 1, a t p a r a . 57  21  Supra , note 1, at para. 62  22  Supra , note 1, at para. 57  23  Supra  24  Supra , note 1, at para. 59  25  Supra , note 2, a t para. 15  26  The U .S. IRC R e g u l a t i o n 1.482 - 2 ( e ) ( 3 ) ( V i ) ( d )  27  Supra  28  The U .S. IRC R e g u l a t i o n 1.482 - 2 ( e ) ( 3 ) ( i i i )  29  Supra , note 2, a t p a r a . 16  30  Supra , note 1, at para. 65  31  Supra , note 1, a t p a r a . 65  32  Supra  33  Supra  note 1, at para. 65  34  Supra  note 1, at para. 66  35  Supra  note 2, a t p a r a . 17  36  Supra. note 1, a t p a r a . 66  37  Supra. note 1, a t p a r a . 66  38  Supra  39  Supra. note 1, at p a r a . 68  40  Supra. note 1, at para. 69  41  Supra, note 1, at para. 69  42  The  43  Supra. note 2, a t p a r a . 17  44  The  45  Supra. note 1, at para. 63  46  Supra. note 2, at para. 19  t  r  r  r  note 1, a t para. 59  note 1, at p a r a . 61  note 1, at p a r a . 65  note 1, a t p a r a . 64  U. S.  IRC R e g u l a t i o n 1.482-- 2 ( e ) ( 4 ) ( i i i )  U. S. IRC R e g u l a t i o n 1.482 - 2 ( e ) ( 4 ) ( v )  48  47  Supra. note 2, at para. 20  48  Supra. note 1, a t p a r a . 71  49  Supra, note 1, at p a r a . 71  50  Supra. note 1, at para. 71  51  Supra  52  Supra. note 1, a t p a r a . 72  53  Supra. note 1, a t p a r a . 14  54  Supra. note 1, at para. 14  55  Supra. note 1, at para. 14  56  Supra, note 1, at para. 14  57  Supra. note 13 , a t 777  58  Supra. note 1, a t p a r a . 14  59  Supra. note 1, at para. 14  60  Supra. note 1, at p a r a . 73  61  Supra. note 1, at para. 74  62  Supra. note 1, at para. 73  63  Supra. note 1, a t p a r a . 74  64  Supra. note 1, at p a r a . 74  65  The U.S.  66  Ibid  t  note 1, at para. 71  IRC R e g u l a t i o n 1 . 4 8 2 - 2 ( e ) ( 1 ) ( i i )  67  N. Boidman, Canada-US Intercompany (and other) Taxation Issues, Report o f the Proceedings o f the T h i r t y - F i f t h Tax Conference. Canadian Tax Foundation (1983), a t 335  68  The U.S.  69  Supra. note 2, a t para.  70  Supra. note 1, a t p a r a . 4  71  Supra, note 2, a t para.  IRC R e g u l a t i o n 1 . 4 8 2 - 2 ( e ) ( 1 ) ( i i i ) 48  21  49 72  Supra, note 1, a t p a r a . 29  73  Supra. note 1, a t p a r a . 29  74  Supra, note 2, a t p a r a . 22  75  Supra. note 1, a t p a r a . 16  76  Supra. note 1, a t p a r a . 16  77  Supra, note 13, a t 778  78  Supra. note 1, a t p a r a . 16  79  Supra. note 1, a t p a r a . 16  80  Supra. note 1, a t p a r a . 16  81  The U.S. IRC R e g u l a t i o n 1 . 4 8 2 - 2 ( a ) ( 2 ) ( i i i )  82  S u b s e c t i o n 17(1) o f t h e Income Tax A c t  83  P a r t X L I I I o f t h e Income Tax R e g u l a t i o n s  84  Supra. note 13, a t 777-778  85  Supra. note 13, a t 778  50  SUBCHAPTER I I I PROVISION OF INTRA-GROUP SERVICES - MANAGEMENT OR ADMINISTRATION SERVICES -  1.  INTRODUCTION  I n MNCs  various  administrative, parent MNCs.  types  of  t e c h n i c a l and commercial  companies o r s p e c i a l i z e d The  depends  nature  on  the  structure of services  and kind  each  are  specialized  intra-group  number of  MNC.  1  initially  service centers  such  as  s e r v i c e s a r e p r o v i d e d by  s u b s i d i a r i e s t o o t h e r members o f of  these  business  and  The  services  intra-group on  services  theorganizational  costs  of  providing  intra-group  incurred  by  a  company  or  i n a variety  of  parent  a n d may b e r e c o v e r e d 2  ways f r o m t h e o t h e r members o f t h e MNC. Since how  a parent  company c a n d e c i d e  i n most c a s e s  t o charge o r a l l o c a t e t h e expenses i n c u r r e d  services,  there  would be t h e p o s s i b i l i t y  for  of shifting  one-sidedly intra-group profits or  3  double dipping. MNCs i n t e r e s t On  the  arrangements expenses, v a r y  Therefore,  i n t r a - g r o u p s e r v i c e arrangements  of  the tax authorities. other  hand,  treatments  f o r t a x purposes, from c o u n t r y  tax authority o f  the  intra-group  such as t h e d e d u c t i b i l i t y  t o country.  country  of  i n which  service of the  F o r example, whereas t h e a  parent  company  is  51  situated,  might  require  the  parent  company t o charge most of  c e n t r a l management o r a d m i n i s t r a t i o n expense i n c u r r e d by its  subsidiaries  abroad.  The  tax  which the s u b s i d i a r y i s s i t u a t e d , as  deductible.  Therefore,  a u t h o r i t y of the country i n  would  be  double or m u l t i p l e t a x a t i o n o f p r o f i t s of a  which  could  intra-group  be  provided  the p o s s i b i l i t y 4  the  independent  s e r v i c e s are s p e c i f i c  to  MNCs  should  principle  provisions  to  be  given  in  of  same  as  parties, because  interdependence or c e n t r a l i z a t i o n . A c c o r d i n g l y , consideration  of  MNC.  s e r v i c e s are  by  to  might not accept such expenses  there  While some o f i n t r a - g r o u p  it,  applying  management  most of  of  special  more d e l i b e r a t e the  or  those  arm's l e n g t h administration  5 services. In  addition,  it  arrangements f o r r e n d e r i n g with  those  for  making  should  be  noted  s e r v i c e s share  some  that  intra-group  common  intangible properties available.  t e c h n i c a l s e r v i c e s are l i n k e d w i t h p a t e n t s or know-how and  not renumerated s e p a r a t e l y ,  require taxpayers to  evaluate  JUSTIFICATION OF BENEFITS  Real b e n e f i t t e s t IC 87-2  states:  Where  contracts  although tax a u t h o r i t i e s u s u a l l y and  charge  become v e r y d i f f i c u l t t o d i s t i n g u i s h .  2.  features  6  separately,  it  may  52 An a l l o c a t i o n o f c e n t r a l management expenses t o a Canadian taxpayer i s a c c e p t a b l e only i f t h e taxpayer i s i n a p o s i t i o n t o d e r i v e a r e a l b e n e f i t from t h e r e l a t e d service. 7 In  other  deductible has  words,  management  expense  to  be  o r chargeable, "who b e n e f i t s from t h e a c t i v i t i e s " t e s t  t o be met.  T h i s r e a l b e n e f i t can be c o n f e r r e d  reasonable expectation if  for central  according  a t t h e time t h e s e r v i c e i s rendered,  to even  i t i s p o t e n t i a l o r intended b e n e f i t .  C e n t r a l management expenses Paragraph 25 expenses i n t o t h r e e  of  IC  87-2  categorizes  central  management  types:  (a) expenses t h a t a r e i n c u r r e d by t h e p a r e n t company i n its "custodial" capacity, i . e . , as a s h a r e h o l d e r managing i t s investments i n s u b s i d i a r i e s r a t h e r than i n the p r o v i s i o n o f s e r v i c e s t o i t s s u b s i d i a r i e s (these expenses s h o u l d be borne by t h e p a r e n t and a p p l i e d a g a i n s t i t s income from i n v e s t m e n t s ) ; (b) expenses such as t h e c o s t s o f t r a i n i n g workers f o r a new p l a n t t h a t a r e c l e a r l y i n c u r r e d f o r t h e b e n e f i t o f a s i n g l e company i n t h e group and a r e a s s o c i a t e d with the p r o v i s i o n of s p e c i f i c i d e n t i f i a b l e s e r v i c e s t o t h a t company; and (c) expenses t h a t are incurred f o r the b e n e f i t of a number o f companies o r t h e group as a whole and a r e f o r shared s e r v i c e s and f a c i l i t i e s , such as a c e n t r a l i z e d world-wide i n s u r a n c e department, that are u s u a l l y c e n t r a l i z e d f o r convenience o r economy. Whereas  t h e expenses o f type  (a) a r e c l e a r l y not chargeable  t o t h e s u b s i d i a r i e s , t h e expenses type  (b) a r e c l e a r l y  t o t h e s u b s i d i a r y and t h e only problem i s t h e the  amount.  The  expenses  of  type  (c)  chargeable  reasonableness  can  of  be chargeable o r  53  allocable to the subsidiaries t o d e r i v e d by  the s p e c i f i c  t h e extent  subsidiary  and  1 0  of  real  present  benefits  complicated  problems.  Shareholder The  costs  expenses o f type  As t h e OECD Report  (a) a r e s o - c a l l e d " s h a r e h o l d e r  costs".  states,  expenses i n c u r r e d by a parent company i n managing and p r o t e c t i n g i t s investment a r e i n c u r r e d by t h e parent company as a s h a r e h o l d e r and would n o t be p r o p e r l y chargeable t o t h e o t h e r members o f t h e MNC. 11 Other expenses such as c o s t s o f t h e p a r e n t ' s subsidiaries,  of i t s  expenses i n c u r r e d by t h e p a r e n t company i n a r r a n g -  i n g meetings o f i t s own s h a r e h o l d e r s and results  audit  o f t h e members o f t h e group,  f o r c o n s o l i d a t i n g the  which may be d i s t i n g u i s h e d  as prima f a c i e i n c u r r e d s o l e l y f o r t h e p a r e n t ' s b e n e f i t , a r e a l s o 12 not chargeable t o t h e o t h e r members o f t h e MNC. Although, such c o s t s  may  t h e OECD be  partly  Report  recognized the p o s s i b i l i t y that  incurred  f o r the b e n e f i t  of the  13 subsidiaries,  MNCs  have complained 14  shareholder costs too broadly,  that the report interprets  and suggested  that  non-deductible  or non-chargeable s h a r e h o l d e r c o s t s should be l i m i t e d s t r i c t l y t o those i n c u r r e d by a parent company s o l e l y i n i t s c a p a c i t y 15 investor  i n t h e o t h e r group a f f i l i a t e .  to coodinating  the various  business  Any c o s t s a t t r i b u t a b l e  activities  s h o u l d n o t be i n c l u d e d i n such s h a r e h o l d e r c o s t s . As  t h e OECD  report  "Transfer  as an  Pricing  of  t h e group  1 6  and M u l t i n a t i o n a l  54 Enterprises:  Three  Taxation  Issues"  ("OECD  1984  Report")  i n d i c a t e s , shareholder costs may be d i s t i n g u i s h e d from c o s t s which a r e i n c u r r e d , i n o r d e r t o render t h e conglomerate more p r o f i t a b l e than the t o t a l o f v a r i o u s i n d i v i d u a l p a r t s o f i t would be i f not r e l a t e d . 17 That  is  to  say,  i t should be r e c o g n i z e d t h a t t h e p r o f i t -  making c a p a c i t y o f s u b s i d i a r i e s o f a MNC  i s o f t e n enhanced by the 18  managerial and c o o r d i n a t i n g a c t i v i t i e s o f a p a r e n t company. T h e r e f o r e , t h e approach which deems t h a t t h e above-mentioned a d d i t i o n a l a c t i v i t i e s by  a  parent  company  are  b e n e f i t o f t h e o t h e r members, might be r e a s o n a b l e . approach,  shareholder  costs,  made  f o r the  Based on t h i s  which should be borne by a parent  company and not d e d u c t i b l e by t h e o t h e r members o f t h e MNC,  would  be l i m i t e d as f o l l o w s : (a) Costs o f a c t i v i t i e s relating to the j u r i d i c a l structure o f t h e parent company i t s e l f , such as meetings o f s h a r e h o l d e r s o f t h e parent, i s s u i n g of the shares i n t h e parent company and c o s t s of the s u p e r v i s o r y board; (b) Costs relating t o r e p o r t i n g requirements o f t h e parent company i n c l u d i n g the consolidation of the reports; (c) Cost o f r a i s i n g funds f o r t h e a c q u i s i t i o n o f i t s participations; (d) Costs o f managerial and c o n t r o l (monitoring) a c t i v i t i e s r e l a t e d t o t h e management and p r o t e c t i o n o f the investment as such i n p a r t i c i p a t i o n s . 19 The c o s t s o f type  ( d ) , as t h e OECD 1984  Report  indicates,  s h o u l d be d i s t i n g u i s h e d from t h e c o s t s o f managerial, c o n t r o l and coodinating  activities  to  improve  the  operation  o f the  55 subsidiaries, persons  20  and  but those a c t i v i t i e s may  be performed by the same  the same departments as the a c t i v i t i e s i n type (d), 21  a c t u a l c l a s s i f i c a t i o n would be v e r y d i f f i c u l t . be  noted  that  management  or  administration  p a r e n t company do not always b e n e f i t the MNC.  It  should  also  a c t i v i t i e s by  other  members  of  the the  22  On the c o n t r a r y , IC 87-2  the tax a u t h o r i t i e s ' approach i s t h a t ,  s t a t e s , u n l e s s the other member o f the MNC  b e n e f i t from the s e r v i c e incurred  by  the  performed  parent  by  the  as  derives a real  parent,  the  costs  company would not be chargeable t o  the  23 other member. The  d i f f e r e n c e i n approach between MNCs and  or between t a x appropriate OECD 1984  authorities  "shareholder  costs"  p r o v i s i o n s of  double  taxation.  on  relevant  a tax  S e r v i c e on  the  t o d e f i n e s p e c i f i c a l l y the scope of b i l a t e r a l b a s i s by r e v i s i n g p r o t o c o l conventions  or  through  follow-up  2 4  call  the  case  of  subparagraph 25(b)  o f IC 87-2,  expenses were c l e a r l y i n c u r r e d f o r the b e n e f i t of the and  as  The  t o simultaneous examination o r through mutual agreement  procedures.  In  cause  ways t o e l i m i n a t e these d i f f i c u l t i e s would be,  Report recommends,  meetings  would  tax a u t h o r i t i e s ,  specific  identifiable  services  were  since  the  subsidiary  provided,  the  only  problem i s the reasonableness of the amount o f expenses. However, such s e r v i c e s are sometimes p r o v i d e d  "on  call",  in  25 r e t u r n f o r payments i n the form of an annual f l a t r a t e f e e .  As  56 the OECD Report i n d i c a t e s , it may w e l l happen t h a t even i f t h e s e r v i c e s a r e not used i n a g i v e n year they may be used i n t e n s i v e l y i n another year, 2 6 therefore, i t would be a p p r o p r i a t e f o r t h e t a x a u t h o r i t i e s t o l o o k a t t h e continuous stream o f a c t i v i t i e s and t h e b e n e f i t s r e c e i v e d over a p e r i o d o f more than one y e a r . 2 7 Indirectness  o r remoteness o f a b e n e f i t  In a l l o c a t i n g t h e expenses i n c u r r e d f o r t h e a c t i v i t i e s which may b e n e f i t t o v a r y i n g or  one  or  more  degrees t h e parent,  other  members  of  t h e group as a whole,  t h e MNC,  i t would be very  d i f f i c u l t t o determine whether a r e a l b e n e f i t has accrued t o t h e other  members o f t h e group.  c e n t r a l management, MNCs  suggest  costs", some  not  Where t h e expenses a r e i n c u r r e d f o r  coodinating be  and  treated  as  control  activities,  non-chargeable  "shareholder  s i n c e such a c t i v i t i e s b e n e f i t p a r t l y t h e p a r e n t  e x t e n t t h e o t h e r members o f t h e MNC,  which  and t o  t h e b e n e f i t which the  s u b s i d i a r i e s c o u l d d e r i v e i s i n d i r e c t o r remote.  28  As t h e OECD Report s t a t e s , "an i n d i r e c t o r remote b e n e f i t t o the  subsidiaries  would  not  justify  a  deduction  for  tax  "whether  the  29  purposes".  Although,  as  the  report  suggests,  member would have bought t h e s e r v i c e had i t been on o f f e r from an 30  independent  third  determine t h e management  party  may  chargeability  expenses,  responsibilities,  also or  i t may  functions,  be  a relevant  factor"  deductibility  of  the  be  to  analyze  necessary  performance  and  profits  to  central the  o f the  31  v a r i o u s members o f t h e MNC.  I n a d d i t i o n , paragraph 26 o f IC 87-2  57  indicates: Where a r e s i d e n t taxpayer i s s t a f f e d by a management team normally associated with a self-sufficient business, t h e a l l o c a t i o n should be l i m i t e d t o expenses t h a t can c l e a r l y be i d e n t i f i e d w i t h t h e taxpayer and which do n o t r e p r e s e n t a d u p l i c a t i o n o f s e r v i c e a l r e a d y p r o v i d e d by Canadian p e r s o n n e l . On t h e o t h e r hand, MNCs seem t o accept t h e " b e n e f i t t e s t " i n the case t h a t s p e c i f i c s e r v i c e s  a r e rendered  to  the  specific  32 subsidiary;  however, they have argued t h a t  costs of central activities f o r the b e n e f i t of the group as a whole should be p a i d f o r by t h e group members, whether o r not a s p e c i f i c b e n e f i t ( a c t u a l o r intended) can be demonstrated, each r e s p e c t i v e share being determined by an a p p r o p r i a t e apportionment formula. 33  3.  METHOD OF AT.T/ir&TION AND APPORTIONMENT  MNCs common c h a r g i n g methods 1  According  t o t h e OECD 1984 Report,  f o l l o w i n g methods t o  charge  central  MNCs u s u a l l y employ t h e  management  costs  to i t s  members: (a) Charging d i r e c t l y f o r i n d i v i d u a l i s e d  services;  (b) A l l o c a t i n g and a p p o r t i o n i n g c o s t s t o each o f t h e associated corporations ( u s u a l l y by r e f e r e n c e t o an e s t i m a t e o f t h e i r share i n t h e b e n e f i t s a r i s i n g from the s e r v i c e s ) - " c o s t s h a r i n g " ; (c) Remunerating t h e group s e r v i c e c e n t e r by a c o n t r i b u t i o n from o t h e r p a r t s o f t h e group r e l a t e d t o some broad aspect of the business o f the e n t e r p r i s e s concerned - e.g. by r e f e r e n c e t o t h e i r g r o s s t u r n o v e r " c o s t f u n d i n g " o r what has sometimes been c a l l e d t h e  58 " f i x e d key" method; (d) The i n c l u s i o n o f a mark-up i n t h e p r i c e o f p r o d u c t s sold t o an a f f i l i a t e by t h e company which i n c u r s t h e c e n t r a l c o s t s . 34 Methods  ( b ) , (c) and  (d) can be c a t e g o r i z e d  as " i n d i r e c t  methods".  Revenue Canada's p e r s p e c t i v e As t h e OECD 1984 Report i n d i c a t e s ,  the d i r e c t  "the advantage t h a t economic r e a l i t y and  fiscal  method  has  p r i n c i p l e s are  35 r e f l e c t e d as f u l l y as p o s s i b l e " ,  and a l s o would be most s u i t a b l e  t o conform t o t h e arm's l e n g t h p r i n c i p l e t h a t p r i c e s f o r s e r v i c e s performed  between  associated corporations 36  should be those which  would be p a i d between u n r e l a t e d p a r t i e s . In  addition,  authorities,  this  since  method  i s very  convenient  f o r tax  i t makes i t p o s s i b l e t o a c h i e v e t h e h i g h e s t  degree o f s e p a r a t i o n and p a s s i n g on o f c o s t i n p r o p o r t i o n t o t h e 37 benefit received and t h e danger o f d u p l i c a t i o n o r double d i p p i n g 38 and  t h e p o s s i b i l i t y o f t h e s h i f t i n g o f p r o f i t s w i l l be reduced. Although Revenue Canada does n o t express i t s p r e f e r e n c e  IC  87-2,  considering  i t s "transaction-by-transaction"  it  seems  to  the d i r e c t  prefer  However,  Revenue  proportion  of the value of the b e n e f i t  relevant  entities  or estimated b a s i s , impose  Canada  seems  method to  to  fully arising  approach,  indirect realize to  in  method. that  the  the  various  cannot be q u a n t i f i e d except on an approximate 39 and t h e r e may be t h e cases where  i t would  an i n t o l e r a b l e a d m i n i s t r a t i v e burden on MNCs t o i n s i s t on  59  the use o f the d i r e c t method. determined reasonable  In o t h e r words, the amounts t o be  are not p r e c i s e l y a s c e r t a i n a b l e , approximation  augment t a x compliance flexible  40  and  i n most cases.  are  rather,  Therefore,  i n the l o n g run,  promote  but  a  i n order to  Revenue Canada should be  the a c c e p t a b l e method which i s compatible  w i t h the t a x p a y e r ' s s i t u a t i o n ,  and i s supported by  documentation  c r e a t e d and maintained by the taxpayer. Accordingly,  as IC 87-2  states,  where the t a x p a y e r ' s b a s i s  of a l l o c a t i o n i s based on a comprehensive review o f  the  central  expenses c a r r i e d out i n advance o f the a l l o c a t i o n , and t h a t b a s i s i s a v a i l a b l e f o r examination by Revenue Canada,  i n d i r e c t methods  41  could  be  accepted  for  t a x purposes.  s t r o n g l y recommended t h a t the Canadian the  In t h i s c o n t e x t , taxpayer  a p p r o p r i a t e s u p p o r t i n g documentation,  should  MNCs  have  complained  that  a  Revenue  complete  a n a l y s i s o f the r e l e v a n t a c t i v i t i e s would impose administrative  burden  on  them,  and  l i m i t the d e d u c t i b i l i t y i n substance, understand  such  documentation  w i t h the t a x p a y e r ' s a b i l i t y , the  maintain  and be c o o p e r a t i v e i n  p r o v i d i n g the necessary i n f o r m a t i o n r e q u i r e d by Although  Canada.  r e c o r d i n g and  an  intolerable  such a heavy burden would Revenue Canada  requirements  s h o u l d be  seems  approach  to  compatible  and taxpayers might be a b l e t o know  d e d u c t i b i l i t y of the expense by the "advance r u l i n g "  Therefore,  i t is  i t can be s a i d t h a t  in  principle  Revenue  system. Canada's  i s reasonable.  As t o what i s the a c c e p t a b l e method, IC 87-2  briefly  states:  60  The b a s i s o f a l l o c a t i o n should r e s u l t i n c o s t s b e i n g shared i n p r o p o r t i o n t o t h e b e n e f i t s r e c e i v e d , f o r example, t h e a l l o c a t i o n of costs of a c e n t r a l i z e d department based on estimate o f time spent on d u t i e s performed f o r each e n t i t y . 43 F u r t h e r c o n s i d e r a t i o n t o be  given  by  taxpayers  could  be  deduced from t h e OECD r e p o r t s .  It the  should  taxpayer  be who  noted t h a t Revenue Canada's a t t i t u d e a g a i n s t was  i n f o r m a t i o n requested  un-cooperative  i s fairly  or f a i l e d t o provide the  strict.  The  mutual agreement procedure by such a taxpayer  requests  f o r the  may n o t be accepted  44 by Revenue Canada.  D i r e c t method As  t h e OECD  Report  suggests,  t o determine t h e amount of  c o n s i d e r a t i o n under t h e arm's l e n g t h p r i n c i p l e "the  open  market v a l u e o f t h e s e r v i c e rendered  by  this  method,  would have t o be  45 established."  U n l i k e i n t h e case o f t r a n s f e r o f goods, t h e OECD  Report suggests t h a t i n f o r m a t i o n about t h e p r i c e s p a i d transactions be looked i t may be services  of  other  a s i m i l a r k i n d between u n r e l a t e d p a r t i e s should  f o r a t f i r s t ; then, necessary to  in  to  look  i n t h e absence o f such i n f o r m a t i o n , at  prices  charged  f o r similar  u n r e l a t e d p a r t i e s by t h e c o r p o r a t i o n which p r o v i d e d 46  the i n t r a - g r o u p s e r v i c e i n q u e s t i o n . I t should be borne i n mind by t a x a u t h o r i t i e s t h a t , the comparable open market p r i c e i s a v a i l a b l e , p r i c e i s n o t always an a p p r o p r i a t e b a s i s  even i f  such a comparable  f o r t h e arm's  length  61 price  because  of  t h e uniqueness o f  group s e r v i c e c e n t e r ,  and so on,  on  and  particular  facts  f u n c t i o n s performed by t h e  d e l i b e r a t e c o n s i d e r a t i o n based  circumstances  of  t h e case should be  47 given. Where t h e comparable open market p r i c e s a r e n o t a v a i l a b l e , as  t h e OECD  helpful  Report  suggests,  c o s t o r i e n t e d method may be 48  i n p r o v i d i n g an approximation t o arm's l e n g t h p r i c e s . "  In t h i s c o s t o r i e n t e d method, service  "a  i n an  s i n c e an independent  supplier  of  arm's l e n g t h s i t u a t i o n would seek t o r e c o v e r a l l  r e l e v a n t c o s t s i n c u r r e d , both d i r e c t and i n d i r e c t c o s t s should be 49 included.  I t i s apparently  difficult  t o determine t h e  indirect  c o s t s a c t u a l l y r e l a t e d t o a p a r t i c u l a r s e r v i c e , and an a p p o r t i o n ment  o f t h e t o t a l r e l e v a n t c o s t s o f t h e s u p p l i e r have t o be made 50  on some reasonable in  fact  basis.  requires  methods.  In  On t h i s p o i n t , a c o s t o r i e n t e d method  s i m i l a r considerations  addition,  i f the cost  as  could  i n the  indirect  n o t be met by t h e  r e c i p i e n t o f t h e s e r v i c e s , t h i s c o s t o r i e n t e d method would not be 51 a p p r o p r i a t e f o r use i n a r r i v i n g a t t h e arm's l e n g t h p r i c e . I n d i r e c t methods Where  i t i sdifficult  d i r e c t - c h a r g i n g method, methods a l s o Whereas  should  o r i n a p p r o p r i a t e f o r a MNC t o use t h e  t h e MNC may use i n d i r e c t methods.  conform  i n t h e d i r e c t method,  to  t h e arm's  the question  amount charged i s an arm's l e n g t h amount, the  question  l e n g t h amount,  length  These  principle.  i s o n l y whether t h e  i n indirect  methods,  i s n o t o n l y whether t h e amount charged i s an arm's but a l s o whether t h e method i s an  arm's  length  62  method.  52  To  be  correspond t o  an  the  arm's  length  arrangements  method,  which  the  would  method should  be  made  between  53 unrelated  parties.  However,  i t should be s t r o n g l y observed by  tax a u t h o r i t i e s , as the OECD 1984  Report suggests,  that  it would be wrong t o ignore completely the s p e c i a l s i t u a t i o n of MNCs and the f a c t t h a t these methods are not applied, or are very seldom a p p l i e d , between u n r e l a t e d p a r t i e s ought not t o l e a d one to conclude that they n e c e s s a r i l y produce charges which must be regarded as not a t arm's l e n g t h . 54 The  OECD 1984  Report a l s o suggests:  The most a p p r o p r i a t e i n d i r e c t method i s generally recognized t o be one which i s based on s h a r i n g among the beneficiaries, i n proportion to the benefits received or expected, the actual costs incurred i n p r o v i d i n g the s e r v i c e s . 55 I t has authority  t o be recognized, has  a  as  tendency  stated  that  earlier,  while  in  that  a  tax  determining  the  c h a r g e a b i l i t y o f c e n t r a l management expenses i n c u r r e d by a parent company which i s s i t u a t e d i n i t s j u r i s d i c t i o n t o i t s s u b s i d i a r i e s abroad, i t may by  using  make the parent company charge as much as  the  "general  benefit  test",  in  possible  determining  the  d e d u c t i b i l i t y of the expenses charged by a f o r e i g n p a r e n t company t o i t s s u b s i d i a r y which i s s i t u a t e d l i m i t the amount d e d u c t i b l e  in i t s jurisdiction,  as small as  possible  " s p e c i f i c b e n e f i t t e s t " . T h i s double standard has 5 6  by  it  using  may the  been producing  57 economic double t a x a t i o n . Since the  main  the main concern o f tax a u t h o r i t i e s , reason  why  tax  authorities  i n o t h e r words,  are r e l u c t a n t t o accept  63 i n d i r e c t methods, i s the danger of double d i p p i n g , charge  or  double d e d u c t i o n and  through i t s i n t r a - g r o u p  i.e.,  double  the s h i f t i n g o f p r o f i t s by a  arrangements,  if  a  MNC  sets  up  arrangement which c o u l d remove the tax a u t h o r i t i e s ' f e a r , be expected t h a t t a x a u t h o r i t i e s would  accept  indirect  MNC the  i t can methods  58  more e a s i l y .  From t h i s v i e w p o i n t ,  the OECD 1984  the f o l l o w i n g p r i n c i p l e s which should making c o s t s h a r i n g or c o s t funding  be  Report suggests  observed  by  MNCs  arrangements:  (a) The method should be laid down in clearly formulated and b i n d i n g c o n t r a c t s , concluded i n advance; (b) These c o n t r a c t s over s e v e r a l y e a r s ;  should  be  observed  consistently  (c) The contracts should apply t o those a s s o c i a t e d e n t e r p r i s e s which w i l l b e n e f i t , or from an ex ante point o f view may be expected t o b e n e f i t , from the activities; (d) The costs o f the relevant a c t i v i t i e s should be determined on the basis of generally-accepted accounting p r i n c i p l e s (such as those u n d e r l y i n g the c o n s o l i d a t e d group's annual r e p o r t ) ; (e) The group members which share the c o s t s should f u l l a c c e s s t o the s e r v i c e s concerned;  have  (f) Where the s e r v i c e s are p r o v i d e d t o t h i r d p a r t i e s as well as to affiliates and, exceptionally, the remuneration from t h i r d p a r t i e s cannot s a t i s f a c t o r i l y be used as the b a s i s f o r the use of a direct-charge method then the c o s t s chargeable should be reduced by the remuneration r e c e i v e d from the t h i r d p a r t i e s ; (g) The c o n t r a c t i n g group members must not pay s e r v i c e s concerned i n any other way;  for  the  (h) A l t e r a t i o n s i n the r e s p o n s i b i l i t i e s and a c t i v i t i e s o f group members which i n f l u e n c e t h e i r b e n e f i t p o s i t i o n should be taken account of as soon as p o s s i b l e in the contracts (changes i n p r o f i t a b i l i t y would not n o r m a l l y j u s t i f y amendment of the c o n t r a c t ) . 5 9  in  64  4 . AMOUNT OF CONSIDERATION  Arm's l e n g t h p r i n c i p l e As s t a t e d e a r l i e r , that  prices  for  corporations  should  the g e n e r a l p r i n c i p l e t o be f o l l o w e d  services  performed  be  which  those  unrelated parties f o r similar  between  would  services.  be  is  associated  paid  between  6 0  P r o f i t mark-up In  determining  charge, the problem  the  reasonable  arm's l e n g t h amount of the  i s whether or not the charge should i n c l u d e a  p r o f i t mark-up. IC 87-2  states:  The amount charged by the n o n - r e s i d e n t should not exceed the expenses t h a t may be allocated t o the Canadian taxpayer as s e t out i n 25(b) and (c)above, i.e., the expenses i n c u r r e d s o l e l y f o r the b e n e f i t of the Canadian taxpayer and a reasonable share of expenses t h a t are i n c u r r e d f o r the b e n e f i t of a number of companies o r the group as a whole... G e n e r a l l y , there i s no p r o f i t element i n shared c o s t s charged t o Canadian branches and s u b s i d i a r i e s . 61 However,  Revenue  Canada  may  accept the p r o f i t element on  charge and a l l o w the t o t a l charge d e d u c t i b l e where a r e a s o n a b l e mark-up on charges f o r s e r v i c e s from a n o n - r e s i d e n t r e l a t e d company which i s i n the b u s i n e s s o f p r o v i d i n g such s e r v i c e s has been made. 62 C o n t r a r y t o Revenue  Canada's  principle,  the  OECD  suggests t h a t the g e n e r a l p r i n c i p l e would be t o expect the  Report charge  65 to  be  based  on c o s t s w i t h an a p p r o p r i a t e mark-up,  s i n c e i n an  arm's l e n g t h s i t u a t i o n , an independent c o r p o r a t i o n would charge f o r t h e s e r v i c e s i t p r o v i d e d  i n such a way as  to  normally recover  63 not o n l y i t s c o s t but a l s o an element o f p r o f i t . the  OECD  Report,  following three  According  to  a p r o f i t mark-up i s always a p p r o p r i a t e i n t h e  cases:  (a) The p r o v i s i o n o f such s e r v i c e s i s one o f t h e main  activities  of a corporation; (b) The  provision  business,  but  supplying  of  the  such  such s e r v i c e s  corporation  services  and  i s not  a main p a r t o f i t s  i s particularly  capable  of  the value o f the s e r v i c e s t o the  r e c i p i e n t i s c o n s i d e r a b l y g r e a t e r than t h e c o s t ; (c) The c o s t o f t h e s e r v i c e s r e p r e s e n t s a s u b s t a n t i a l 64  proportion  of t h e expenses o f t h e r e c i p i e n t ' s b u s i n e s s . On t h e o t h e r hand, i t has t o be r e c o g n i z e d ,  as t h e OECD 1984  Report a l s o i n d i c a t e s , t h a t in p r a c t i c e t h e f u n c t i o n and s i t u a t i o n of service departments o f MNEs may d i f f e r c o n s i d e r a b l y from those of independent b u s i n e s s e s performing t h e same k i n d s o f s e r v i c e . 65 The r e p o r t c o n t i n u e s : One important d i f f e r e n c e i s t h a t i n many cases group service departments may render s e r v i c e s t o group members o n l y . The f u n c t i o n o f a department o f t h i s kind i s essentially t o reduce t h e c o s t s o f t h e group and thus t o a s s i s t t h e group as a whole t o make a profit, r a t h e r than, as i n t h e case o f an independent b u s i n e s s , t o make a p r o f i t f o r i t s e l f . 66 Therefore  i t may  be reasonable  c o u l d n o t seek t o r e c o v e r more than members  of  the  t o accept t h a t t h e company  i t s costs  group i n such cases,  from  the  other  and as a c o r o l l a r y o f t h e  66 above-mentioned arm's l e n g t h  p r i n c i p l e , i f the s e r v i c e i s u s u a l l y  performed between u n r e l a t e d  parties  profit  be  mark-up  need  not  on  made  a  on  cost-price charges  basis,  a  of intra-group  67 services. D e s p i t e t h e above-mentioned d i f f e r e n c e s Revenue  Canada and the OECD r e p o r t s ,  a t t i t u d e o f Revenue solutions  for  Canada  taxpayers.  between t h e r e l e v a n t double  to  to  have  the  the f l e x i b l e  found  satisfactory  differences  t a x a t i o n would depend on mutual agreement procedures,  or  meetings  to  authorities,  simultaneous  the  i n approach of  authorities. 5.  As  i n practice,  between  solution  follow-up  tax  seems  i n approach  final  examination  between  tax  6 8  SUMMING UP  Canadianism It  might be an i n t e r e s t i n g phenomenon t h a t whereas the U.S.  IRS has been t r y i n g t o make the U.S. charge  the  subsidiaries strictly  central as  much  interpreting  management as  Revenue  expenses  possible,  "real  w i t h t h e d e d u c t i b i l i t y o f such subsidiaries.  parent  of  to  Canadian  Revenue  benefits", expenses  Canada's  companies their Canada  and has been paid  perspective  by  on  Canadian  management since  a  o f Canadian l a r g e companies are s u b s i d i a r i e s o f the U.S.-  based MNCs, the  been  reluctant  the  expenses o f MNCs might be r a t i o n a l i z e d by the f a c t t h a t number  has  MNCs  a l a r g e amount o f management f e e s have been p a i d  by  Canadian taxpayers t o t h e U.S. o r o t h e r f o r e i g n companies and  67  significant  portion  o f such payments are abused f o r the purpose  of maximizing o v e r a l l a f t e r - t a x p r o f i t s o f MNCs: f o r example as a means o f t h e s h i f t i n g of p r o f i t s o r double d i p p i n g . Although  the a t t i t u d e of Revenue Canada has been  by MNCs and tax p r a c t i t i o n e r s ,  criticized  as so s t r i c t t h a t sound  business  69  a c t i v i t i e s of MNCs have been d i s t o r t e d ; Canada,  there  are  opinions  approach i s encouraging  that  i n the tax community of  the p r e s e n t Revenue Canada's  foreign-based  MNCs  to  truncate  Canadian o p e r a t i o n s and do the work o u t s i d e Canada. their  opinion,  present  tax  treatments  of  their  According to  management f e e s or  expenses are too generous, s i n c e no w i t h h o l d i n g t a x e s are imposed on the payments under s u b s e c t i o n 212(4) o f the Income Tax A c t 70 such payments are d e d u c t i b l e i n Canada i f reasonable. payments t o the U.S. -U.S.  parent companies,  Income Tax Convention, 71  to withholding taxes.  In  and  As t o the  thanks t o the new  Canada  any management f e e s are not s u b j e c t the  view  of  their  "Canadianism",  Canada s h o u l d not permit the Canadian s u b s i d i a r i e s deductions f o r all  expenses  reimbursed  those f u n c t i o n s c o u l d  to  and  the  should  f o r e i g n p a r e n t companies when ordinarily  be  performed  in  72 Canada.  They  also  suggest t h a t whereas Revenue Canada should  g r a n t b e n e f i t o f the doubt t o Canada-based room  for  the  abusive  use  MNCs,  of management f e e s by  tight  up  the  foreign-based 73  MNCs, w i t h i n d i s c r e t i o n a r y power o f Revenue Canada. However, such a p a t r i o t i c approach does not conform t o the 74 OECD Model Double T a x a t i o n Convention and would make MNCs 75 manipulate the t r a n s f e r p r i c e s i n o t h e r types of t r a n s a c t i o n s .  68  Part XIII tax By v i r t u e o f paragraph 212(1)(a) management  or  other  hand,  subsection  the  intra-group  of  management  fee,  Part  performance o f a s e r v i c e ,  the n o n - r e s i d e n t  XIII  t a x . In  i f t h e amount was a  reimbursement o f a s p e c i f i c expense i n c u r r e d by the  subject to  212 (4) p r o v i d e s t h e case  c e r t a i n management fees from  for  Tax A c t ,  withholding tax.  which excludes case  Income  i s s u b j e c t t o 25 p e r c e n t ,  r e d u c t i o n by t h e t a x conventions, the  the  a d m i n i s t r a t i o n f e e s o r charges t h a t a r e s i d e n t o f  Canada pays t o n o n - r e s i d e n t  On  of  the non-resident  and t h e s e r v i c e performed by  was f o r t h e b e n e f i t o f  e x t e n t t h a t such payment i s reasonable  t h e payer,  and  to  i n t h e circumstances,  the such 76  an  i n t r a - g r o u p management f e e i s not s u b j e c t t o P a r t X I I I t a x .  A c c o r d i n g l y , o n l y t h e excess over t h e above-mentioned amount w i l l be s u b j e c t t o P a r t X I I I t a x and w i l l be d i s a l l o w e d under 67  and  section 77  s u b - s e c t i o n 69(2) as an expense o f t h e Canadian payer.  As t o t h e reasonableness,  t h r same c r i t e r i a as under P a r t  I  of  the Income Tax A c t a r e t o be a p p l i e d . New Canada-U.S. Income Tax Convention t r e a t s management as i n d u s t r i a l , Article Canadian  VII  commercial o r b u s i n e s s p r o f i t s , o f t h e convention,  resident  withholding  tax  to to  the  the  U.S.  extent  as IC 87-2 s t a t e s :  and by v i r t u e o f  t h e management f e e s p a i d by t h e resident  is  not  i t i s reasonable  under P a r t I o f t h e Income Tax Act, v i c e v e r s a . Therefore,  fees  subject  to  and d e d u c t i b l e  69 As a consequence o f a p p l y i n g t h e terms o f the 1980 convention t o payments after 1984, the previous importance o f the management f e e i s s u e have been g r e a t l y reduced. 78  70  SUBCHAPTER I I I - FOOTNOTES  1  The A l l o c a t i o n o f C e n t r a l Management and S e r v i c e Transfer Pricing and M u l t i n a t i o n a l Enterprises: T a x a t i o n Issues, Report o f t h e OECD Committee on A f f a i r s (1984), a t para. 3  Costs, Three Fiscal  2  T r a n s f e r P r i c i n g and M u l t i n a t i o n a l E n t e r p r i s e s . Report o f t h e OECD Committee on F i s c a l A f f a i r s (1979), a t p a r a . 139  3  Supra. note 1, a t p a r a . 16  4  Supra. note 1, a t para. 18  5  Supra, note 2, a t p a r a . 143  6  Supra. note 2, a t p a r a . 141  7  Revenue Canada, I n t e r n a t i o n a l T r a n s f e r P r i c i n g and Other I n t e r n a t i o n a l T r a n s a c t i o n s , I n f o r m a t i o n C i r c u l a r 87-2 (1987), a t p a r a . 26  8  Supra. note 1, a t p a r a . 4  9  Supra. note 2, a t para. 151  10  Supra, note 7, a t p a r a . 26  11  Supra. note 2, a t p a r a . 154  12  Supra. note 2, a t p a r a . 154  13  Supra, note 2, a t para. 156  14  Supra. note 1, a t para. 23  15  Supra. note 1, a t p a r a . 34  16  Supra. note 1, a t para. 34  17  Supra. note 1, a t p a r a . 35  18  Supra, note 1, a t p a r a . 37  19  Supra. note 1, a t para. 38  20  Supra. note 1, a t p a r a . 39  21  Supra. note 1, a t p a r a . 39  71  22  Supra, note 2, a t p a r a . 156  23  Supra. note 7, a t para. 26  24  Supra. note 1, a t p a r a . 43  25  Supra. note 2, a t para. 146  26  Supra. note 2, a t para. 152  27  Supra. note 2, a t p a r a . 152  28  Supra, note 2, a t p a r a . 157  29  Supra. note 2, a t para. 153  30  Supra, note 2, a t p a r a . 157  31  Supra. note 2, a t para. 159  32  Supra. note 1, a t p a r a . 25  33  Supra, note 1, a t p a r a . 25  34  Supra. note 1, a t p a r a . 45  35  Supra. note 1, a t p a r a . 53  36  Supra. note 2, a t p a r a . 160  37  Supra. note 1, a t para. 54  38  Supra. note 1, a t para. 56  39  Supra. note 1, a t p a r a . 59  40  Supra, note 1, a t p a r a . 60  41  Supra. note 7, a t para. 27  42  Supra. note 1, a t p a r a . 60  43  Supra. note 7, a t para. 27  44  Revenue Canada, Requests f o r Competent A u t h o r i t y Consideration - Double T a x a t i o n Issues, I n f o r m a t i o n C i r c u l a r 71-17R2 (1984), a t p a r a . 10  45  Supra. note 2, a t para.  164  46  Supra, note 2, a t p a r a .  164  72 47  The U.S. IRC R e g u l a t i o n 1.482-2(b)(3)  48  Supra. note 2, at para. 165  49  Supra. note 2, at para. 165  50  Supra. note 2, at p a r a . 165  51  Supra. note 2, at p a r a . 169  52  Supra. note 2, at para. 63  53  Supra, note 1, at para. 63  54  Supra. note 1, a t p a r a . 63  55  Supra. note 1, at para. 65  56  Supra. note 1, a t p a r a . 30  57  Supra. note 1, at p a r a . 31  58  Supra, note 1, at para. 67  59  Supra. note 1, at p a r a . 67  60  Supra, note 2, at para. 160  61  Supra. note 7, at p a r a . 30  62  Supra. note 7, at para. 30  63  Supra. note 2, at para. 167  64  Supra. note 2, at p a r a . 168  65  Supra  66  Supra. note 1, at para. 81  67  Supra. note 1, a t p a r a . 77  68  Supra. note 1, at p a r a . 86  69  N. Boidman, Canada-US Intercompany (and other) T a x a t i o n Issues, Report o f t h e Proceedings o f t h e T h i r t y - F i f t h Tax Conference. Canadian Tax Foundation (1983), a t 351-352  70  J . S. Peterson, I n t e r n a t i o n a l T r a n s f e r P r i c i n g : A Canadian Perspective, Report o f t h e Proceedings o f t h e T h i r t y - F i r s t Tax Conference. Canadian Tax Foundation (1979), a t 466  71  A r t i c l e V I I o f t h e Canada-U.S.  f  note 1, at p a r a . 81  Income  Tax  Convention.  The  73 same approach i s adopted Convention ( A r t i c l e V I I ) .  in  the  Canada-U.K.  Income Tax  72  Supra, note 70, a t 467  73  Supra, note 70, a t 468-469  74  A r t i c l e 24 o f t h e OECD MOdel Double T a x a t i o n Convention  75  Supra, note 1, a t p a r a . 13  76  Revenue Canada, Income Tax A c t : Fees p a i d t o Non-Residents, (1981), a t p a r a . 4  77  Ibid, para. 8  78  Supra. note 7, a t p a r a . 33  Management o r A d m i n i s t r a t i o n Interpretation Bulletin-468  74  SUBCHAPTER IV TRANSFER OF TECHNOLOGY - USE OF INTANGIBLE PROPERTY -  1.  INTRODUCTION  The r e s e a r c h and development  ("R &  D")  activities  a r e of  vital  importance f o r MNCs t o keep t h e i r growth and p r o f i t a b i l i t y  in  world  a  market.  industries, the R & D to  Especially  in  technology  a c t i v i t i e s a r e i n e v i t a b l e and i n d i s p e n s a b l e  c o n t i n u e t h e i r e x i s t e n c e as economic e n t i t i e s .  spending a huge amount o f R & D In  a  MNC,  undertakes R & D , members  of  the  a  intensive  parent  expenses.  company  Thus MNCs are  1  usually,  but  not  and makes t h e r e s u l t s a v a i l a b l e t o group,  and  recovers  the  always,  the  expenses  other  from such  members. There a r e a number o f ways t o make a v a i l a b l e t h e r e s u l t o f R &  D  t o t h e members,  and t o f i n a n c e  (or recoup) R & D  expenses.  Such ways can be c a t e g o r i z e d as f o l l o w s : (a)  The parent company o r o t h e r company which  makes  available  the  undertook  R & D  r e s u l t s t o t h e o t h e r members o f t h e MNC by  l i c e n s i n g agreements and r e c e i v e s t h e r o y a l t y  o r f e e f o r t h e use  of p a t e n t s o r know-how, e t c . ; (b)  The  parent  company  o r o t h e r company which undertook  R&D  makes a " c o s t c o n t r i b u t i o n arrangement" w i t h o t h e r members o f the  75 MNC  ( i n advance).  pays  i t s share  Under t h i s arrangement,  t h e member o f t h e MNC  o f t h e expenditure t o f i n a n c e R & D  and w i l l be  e n t i t l e d t o a f a i r share o f t h e r e s u l t s o f t h e R & D ; (c)  Where t h e R & D i s undertaken a t t h e s p e c i f i c request o f one 2  member o f t h e MNC, t h e expense i s borne by t h a t member. Since  MNCs  are  in a  p o s i t i o n t o adopt any measure which  b e n e f i t s them,  they  might  agreements  cost  contribution  or  use  the  a l l e v i a t e t h e o v e r a l l t a x burden as manipulating  the p r i c i n g  basis of cost a l l o c a t i o n , entity  above-mentioned  arrangements a  group.  as For  licensing vehicles to  example,  by  p o l i c y o f l i c e n s i n g agreements o r t h e a MNC c o u l d s h i f t  t o t h e o t h e r i n t h e group.  Or,  t h e p r o f i t from  R&D  one  expenses which a r e  shared by t h e s u b s i d i a r i e s might be i n c l u d e d i n t h e p r i c e o f t h e 3  p r o d u c t s which a r e purchased by t h e s u b s i d i a r i e s . On  the  other  hand,  since  t h e treatments  of  licensing  agreements o r c o s t c o n t r i b u t i o n arrangements o r R & D expense f o r tax  purposes v a r y from country t o country, even i n t h e case where  the  MNC has no i n t e n t i o n o f a v o i d i n g o r evading tax,  policy  i t s pricing  o r c o s t a l l o c a t i o n b a s i s would n o t n e c e s s a r i l y p r o v i d e an  acceptable b a s i s f o r the determination of taxable p r o f i t s f o r the 4  relevant tax authorities. In t h i s subchapter, t h e l i c e n s i n g agreements, i . e . , r o y a l t y payments  f o r patents  o r know-how and c o s t c o n t r i b u t i o n arrange-  ments w i l l be d i s c u s s e d .  76  2.  LICENSING AGREEMENTS - ROYALTY PAYMENT FOR PATENTS OR KNOW-HOW DEVELOPED BY ONE MEMBER OF A MNC FOR OTHER MEMBERS OF THE MNC -  Use o f i n t a n g i b l e p r o p e r t y v s . o u t r i g h t t r a n s f e r o f i n t a n g i b l e property Before l o o k i n g agreements,  i n t o t h e arm's-length p r i n c i p l e i n l i c e n s i n g  i t i s necessary t o d i s t i n g u i s h between t h e r o y a l t y  payment f o r p a t e n t s and t h e payment patents.  f o r outright  transfer  of  5  The r o y a l t y i s t h e payment made t o t h e owner o f t h e p r o p e r t y for and  the  right  t o use such p r o p e r t y f o r a g i v e n p e r i o d  has a n a t u r e o f c u r r e n t  expense  and  i s deductible  o f time, i n the  t a x a t i o n y e a r i n which t h e payment i s made. On t h e o t h e r hand, intangible  property  t h e payment  f o r outright  i s c a p i t a l outlay  under t h e Income Tax A c t .  A c c o r d i n g t o t h e case laws, 7  of  and cannot be deducted i n  the t a x a t i o n y e a r i n which t h e payment i s made amortization  transfer  and  subject  to  6  t h e r e may be a case t h a t even a  lump sum payment can be r o y a l t y  and i t can be s a i d t h a t t h e r e i s  no  and  standpoint  to  distinguish  i t i s necessary  t o judge  c a r e f u l l y under each c i r c u m s t a n c e s . The same arm's l e n g t h p r i n c i p l e as i n t h e case of  goods  will  apply  to  p r o p e r t y , m u t a t i s mutandis.  the o  outright  of  transfer  transfer of intangible  77  Know-how f e e v s . s e r v i c e f e e As t h e OECD distinguish property  Report  indicates,  i t i s also  necessary  to  t h e t r a n s f e r making a v a i l a b l e t h e use o f i n t a n g i b l e  t o another p a r t y ,  activities  or  similar  from t e c h n i c a l a s s i s t a n c e o r activities  which  constitute  similar personal  9  services. Especially, u n l i k e a patent,  "know-how"  needs c a r e f u l c o n s i d e r a t i o n ,  which i s a l e g a l l y p r o t e c t e d monopoly r i g h t  an i n v e n t i o n , a know-how i s a l e s s p r e c i s e concept. the commentary on A r t i c l e 12 o f t h e OECD Convention,  Model  i n the application of  the know-how by t h e l i c e n s e e , the r e s u l t t h e r e o f .  and t h e g r a n t o r  On t h e other hand,  of services,  Taxation  i s not required  the  formulae  of  does n o t guarantee  i n the contract f o r  the  one o f t h e p a r t i e s undertakes t o use t h e  customary s k i l l s o f h i s c a l l i n g t o execute party.  to  According t o  Double  i n t h e know-how c o n t r a c t t h e g r a n t o r  t o p l a y any p a r t h i m s e l f  provision  since  work  f o r the  other  1 0  However,  i t i s very d i f f i c u l t  these two t y p e s o f c o n t r a c t s , include a service  element  1 1  t o draw a b o r d e r l i n e between  s i n c e most o f and  know-how  especially,  MNCs  contracts  often  make  "package d e a l s " . Justification of benefit To make t h e payment f o r t h e use o f t h e p a t e n t ("royalty") conferred  deductible,  f i r s t of a l l ,  o r c o u l d be r e a s o n a b l y expected  or  know-how  a r e a l b e n e f i t has t o be at  t h e time  of the  78  conclusion justify  of  the  licensing  t h e payment  agreement.  12  f o r t a x purposes,  I n o t h e r words, as  t h e OECD  to  Report  suggests, it has t o be demonstrated t h a t t h e p a t e n t o r know-how i n q u e s t i o n i s i n f a c t u s e f u l f o r t h e p a r t i c u l a r needs of the corporation paying f o r them and t h a t a r e a l b e n e f i t i s thereby c o n f e r r e d . 13 Arm's l e n g t h p r i n c i p l e i n l i c e n s i n g agreements A f t e r t h e j u s t i f i c a t i o n o f b e n e f i t s i s made, t h e t e s t o f t h e arm's l e n g t h p r i n c i p l e has t o be met. The  general  principle  i s that  the  between one member which undertook R & D know-how,  u s u a l l y a parent  MNC should unrelated  correspond parties  to  company, those  i n terms  of  l i c e n s i n g agreements  and owns t h e  patent  or  and t h e o t h e r member o f t h e  that the  would form  be and  made  between  amount  of the  14 consideration. First,  t h e payments i n l i c e n s i n g  agreements  l e n g t h s i t u a t i o n s should be i n a form which  i n non-arm's  i s compatible  with  the form which would be adopted i n t r a n s a c t i o n s between u n r e l a t e d 15 parties  under t h e s i m i l a r circumstances.  royalty  payment  i n question  payments, o r d e g r e s s i v e  may  take  Therefore, a  Second,  to tax a u t h o r i t i e s . the  of  recurrent  payments, o r lump sum payments, i f such a  form would be u s u a l between u n r e l a t e d p a r t i e s , be a c c e p t a b l e  form  where t h e  t h e payment would  1 6  amount o f an arm's l e n g t h c o n s i d e r a t i o n  should  be t h e amount t h a t would have been p a i d by an u n r e l a t e d p a r t y f o r the same o r s i m i l a r i n t a n g i b l e p r o p e r t y under t h e same o r s i m i l a r  circumstances.  That i s t o say,  comparable u n c o n t r o l l e d intangible  property.  p r i c e method w i l l Where  agreement w i t h u n r e l a t e d intangible  property  apply  to  the  the  use  of  the same d e v e l o p e r made a l i c e n s i n g  p a r t i e s i n v o l v i n g the  under  comparable u n c o n t r o l l e d  as i n the t r a n s f e r of goods,  the  same  or  similar  same or s i m i l a r c o n d i t i o n ,  this  p r i c e method would be the b e s t method  to  18 c a l c u l a t e the arm's l e n g t h p r i c e . very  difficult  transactions, usually  to  find  However,  satisfactory  s i n c e the owner of the  in practice,  comparable  open  i t is market  intangible property i n a  does not make i t a v a i l a b l e t o u n r e l a t e d p a r t i e s and 19  an i n t a n g i b l e p r o p e r t y i s unrelated  parties  the p r i c e i n unrelated  a  monopoly  right.  The  MNC such  offers  or the genuine b i d s of competing l i c e n s e e s  sub-licensing  contract  by  the  licensee 20  to  to or the  p a r t y might be u s e f u l data f o r t h i s method.  However, the OECD Report s t a t e s : It i s c o n s i d e r e d t h a t i t i s u n l i k e l y t o be p o s s i b l e t o construct any standard rates, such as a certain percentage of s a l e s , s i n c e even w i t h i n a g i v e n s e c t o r of i n d u s t r y i t i s extremely d i f f i c u l t to discern any t y p i c a l r a t e o r range of r a t e . 21 Revenue 45 o f IC 87-2  Canada  a l s o r e a l i z e s such a d i f f i c u l t y .  Paragraph  states:  The best can be expected i s t o draw comparisons w i t h royalty rates i n the same i n d u s t r y or a similar industry, involving relatively s i m i l a r products, s i m i l a r market c o n d i t i o n s and similar licensing arrangement. Where the tax a u t h o r i t i e s t r y t o price  in  intra-group  arrive  l i c e n s i n g contracts  at  an  acceptable  by u s i n g the  evidence  80 p r o v i d e d by t h e "comparable " t r a n s a c t i o n ,  i t i s necessary  to  22 take a l l t h e circumstances i n t o account. l i s t s the following  items as f a c t o r s t o be taken i n t o account:  (a) P r e v a i l i n g r a t e s from  the  i n the industry:  publication  always s a i d t h a t  Paragraph 46 o f IC 87-2  and  similar  Those r a t e s can be obtained  market  surveys.  industries  have  S i n c e i t cannot be similar  d i s c r e p a n c y from t h e average i n d u s t r y r a t e  may  not  rates,  the  necessarily  i n d i c a t e t h e unreasonable r a t e ; (b) Terms exclusive  of the license, rights:  including  geographic l i m i t a t i o n  Whereas some l i c e n s i n g agreements may  and  include  the r i g h t s t o make, use and s e l l , t h e o t h e r s may i n c l u d e only one of  these.  The  payments  payment f o r an e x c l u s i v e 23  therefore  should  be  different.  The  l i c e n s e should be h i g h e r than t h a t f o r a  non-exclusive l i c e n s e ; (c) S i n g u l a r i t y o f t h e i n v e n t i o n likely  to  remain  unique:  payment c o n s i d e r a b l y . should  be  higher  and t h e p e r i o d  The  nature  the  royalty  i t is  of a patent a f f e c t s the  The r o y a l t y f o r t h e  than  f o r which  "beakthrough"  f o r the  patent  p a t e n t which i s  designed t o improve t h e e x i s t i n g patent, o r f o r which 24  substitutes  are r e a d i l y a v a i l a b l e ; (d) T e c h n i c a l along  assistance,  with access t o the patent:  fee f o r a s s i s t a n c e , under  trade-marks  such  a  and  "know-how"  provided  Unless the l i c e n s o r invoices a  trade-mark and know-how s e p a r a t e l y ,  l i c e n s i n g agreement might be h i g h e r than  royalty ordinary  25 cases; (e) P r o f i t s a n t i c i p a t e d by t h e gross  profit  margin  on  licensee:  products  under  As  a  corollary,  the  t h e l i c e n s e should be  81 h i g h e r than t h a t on o t h e r p r o d u c t s not p r o t e c t e d by the patent  or  know-how; (f) B e n e f i t s t o the l i c e n s o r a r i s i n g from the s h a r i n g on the experience impart  further  of the l i c e n s e e :  information  I f the l i c e n s e e i s o b l i g e d t o  improvement o f the i n v e n t i o n under the  licensing 26  agreement, t h i s should In  addition  to  i n f l u e n c e the amount o f the payment. the above-mentioned items,  the degree  and  d u r a t i o n o f p r o t e c t i o n a f f o r d e d t o the p r o p e r t y under the laws of 27 the r e l e v a n t c o u n t r i e s might be r e l e v a n t f a c t o r s . Where a comparable u n c o n t r o l l e d t r a n s a c t i o n cannot be o t h e r methods have t o be used t o f i n d the reasonable 28 p r i c e f o r tax purposes.  found,  arm's l e n g t h  Since Revenue Canada does not s t a t e the  o t h e r methods t o be a p p l i e d i n IC 87-2,  i t might be  appropriate  t o deduce them from the OECD Report. One make  a  i s the " p r o f i t comparison approach". pragmatic  engaged  i n the same a r e a .  to  a p p r a i s a l of the t r e n d of a company's p r o f i t s  over a l o n g p e r i o d i n comparison w i t h those parties  T h i s method i s  of  other  i n the same or s i m i l a r a c t i v i t i e s and 29 However,  i n most cases  j u s t i f y h i s unusual p r o f i t w i t h many reasons,  the and  unrelated operating  taxpayer as  the  could OECD  Report i n d i c a t e s : I t would be v e r y d i f f i c u l t t o isolate the respective profits of the l i c e n s o r and l i c e n s e e s i n c e a number of r i g h t s may be under l i c e n s e a t the same time for manufacturing o f the different p r o d u c t s and since accounting methods i n the countries concerned may d i f f e r fundamentally. 30 Therefore, t h i s method c o u l d be only useful to indicate  82  whether  the  property  may o r may not be reasonable.  The of  R  other  &  D  However, not  consideration  charged  f o r the  i s t h e " c o s t " method.  basis  to  consider  use o f i n t a n g i b l e  T h i s method make  an  arm's  the  cost  length r o y a l t y rate.  t h e a c t u a l open market p r i c e o f i n t a n g i b l e p r o p e r t y  be r e l a t e d i n a c o n s i s t e n t manner t o t h e c o s t s o f  i t and t h e p r i c e o f t h e s u c c e s s f u l i n v e n t i o n  may  may  developing  often  include  31 the c o s t o f u n s u c c e s s f u l  R&D.  In a d d i t i o n , i t i s d i f f i c u l t t o  determine s p e c i f i c amounts o f c o s t s i n v o l v e d p a r t i c u l a r i n t a n g i b l e property,  in  R  &  e s p e c i a l l y when R & D  are performed i n a group on a l a r g e s c a l e  and  D  for a  activities  f o r the  various  32 purposes. for  Therefore,  the  t h e arm's l e n g t h r o y a l t y ,  d i f f i c u l t i e s , t h e OECD Report There may be cases where some guidance, at least the l i c e n s o r ' s p r o f i t i n The U.S.  c o s t should but  not form t h e o n l y  despite  IRS seems t o adopt t h i s method as a secondary method.  a p r o v i s i o n a l l y acceptable  been a p p l i e d , method  above-mentioned  indicates: t h e c o s t - o r i e n t e d method g i v e s as regards t h e lower l i m i t f o r normal c i r c u m s t a n c e s . 33  These other methods c o u l d be a t l e a s t verify  the  basis  in  as  means  to  p r i c e a f t e r o t h e r methods have  and i t might be necessary t o  arriving  useful  use  more  than  one  a t a s a t i s f a c t o r y approximation t o an arm's  34  length p r i c e .  Double d i p p i n g Another g e n e r a l length  royalty  is  p r i n c i p l e t o determine t h e a c c e p t a b l e that  arm's  t h e r e should be no double d e d u c t i o n o r  83  double charge  f o r the  use  of  the  intangible  property.  35  For  example, t h e f o l l o w i n g cases c o u l d be assumed: (a) Where t h e company paying r o y a l t y f o r t h e p a r t i c u l a r p a t e n t t o its  foreign  parent company  a c q u i r e s t h e product made under t h e  p a t e n t i n f i n i s h e d s t a t e , t h e p r i c e f o r those goods might the R & D  expense o f t h e p a t e n t ;  (b) The company which shared t h e R & D patent  include  with  i t s foreign  parent  expense f o r t h e p a r t i c u l a r  company  through  the  cost  c o n t r i b u t i o n arrangement might make a l i c e n s i n g agreement f o r the patent; (c) The  parent  company  may  charge  management f e e s which i n c l u d e s  the  which  in  were  already  included  i t s foreign  salaries the  of  subsidiary  t h e engineers,  c a l c u l a t i o n of the  expense i n t h e c o s t c o n t r i b u t i o n agreement w i t h t h a t  R&D  subsidiary;  (d) Where a MNC has two f o r e i g n s u b s i d i a r i e s i n t h e same country, one o f which i s a manufacturing  e n t i t y and t h e o t h e r a  entity,  might  the  parent  company  charge  both  marketing  subsidiaries  royalties.  Revenue Canada seems t o pay much a t t e n t i o n i n t h i s problem.  3.  COST CONTRIBUTION ARRANGEMENTS FOR R & D  EXPENDITURE AMONG  MEMBER COMPANIES OF MNCS  C o s t c o n t r i b u t i o n arrangement As  a means t o make a v a i l a b l e t h e r e s u l t o f R & D a c t i v i t i e s  84  t o the a s s o c i a t e d companies and them,  some MNCs use the  types:  One  o f a MNC  e x p e n d i t u r e from  " c o s t c o n t r i b u t i o n arrangement"  of l i c e n s i n g agreements. contribution  recoup the R & D  According  arrangement  can  instead  t o the OECD Report, t h i s  be  roughly  categorized  cost  into  two  i s the " c o s t s h a r i n g arrangement" under which members  agree t o share the a c t u a l c o s t s  undertaken  for  and  risks  of  R  &  D  the b e n e f i t or expected b e n e f i t of each of them,  and would i n r e t u r n be e n t i t l e d t o i t s f a i r share of  any  usable  36  results  of  the  R  &  D.  The  other  is  arrangement" under which members of a MNC general  way  to  the  R&D  the  "cost  contribute  expenditures of the MNC  funding  in  a  more  and would be  37  e n t i t l e d t o use types  is  the r e s u l t s .  that  under  The  the  d i f f e r e n c e between  cost  funding  be  fee,  and  r e l a t e d t o the a c t u a l c o s t o f R & D a c t i v i t i e s ,  a c t u a l r e s u l t s o f R & D may  two  arrangement,  c o n t r i b u t i o n would take the form of a g e n e r a l i s e d not  these  the would  and  the  be owned by a s i n g l e company, u s u a l l y  38  a parent company. The  c o s t c o n t r i b u t i o n arrangement has  s e v e r a l advantages f o r  MNCs: For example, each member company has  a b e t t e r chance t o  access  programs  to  the  benefits  from  research  magnitude i n r e t u r n f o r reimbursing of the c o s t s .  This  arrangement  all,  the  advance  recoup  9 For 3the tax involved.  rapidly  and  authorities,  large  a  more  l i c e n s i n g agreements, and  above  can  alleviate  however  this  simpler  share  and  company which undertakes R & D or  a  only a r e l a t i v e l y small  provides  e q u i t a b l e method than i n t r a - g r o u p  of  get  f i n a n c e the c o s t i n the cost  risk  to  be  contribution  85 arrangement t h a t a MNC  presents  a number o f d i f f i c u l t i e s .  could s h i f t t h e i r  a r b i t r a r y a l l o c a t i o n of cost,  profit  among  T h e i r concern i s  i t s members  by double d i p p i n g ,  by  an  o r by t r e a t i n g  c a p i t a l expenses as c u r r e n t expenses. Considering to  the above-mentioned advantages,  i t i s necessary  accomodate t h e e x i s t e n c e o f t h e c o s t c o n t r i b u t i o n arrangement 40  of  MNCs.  However,  it  is  important  s c r u t i n i z e the d e d u c t i b i l i t y o r  for  tax a u t h o r i t i e s to  chargeability  of  the  expenses  under the c o s t c o n t r i b u t i o n arrangements. In t h e U.S.,  i f a p a r t i c u l a r c o s t s h a r i n g arrangement meets  the c o n d i t i o n s p r o v i d e d  by the IRC R e g u l a t i o n ,  be allowed f o r t a x purposes t o charge o r 41 the a c t u a l c o s t i n v o l v e d . In Canada,  the d e d u c t i b i l i t y o f R & D  the t a x p a y e r w i l l  t o deduct  as  expenses  expenses under P a r t I  of Income Tax A c t i s determined by the f o l l o w i n g p r i n c i p l e s , Justification of benefits IC 87-2  states:  The Canadian t a x p a y e r s o b v i o u s l y must be i n a p o s i t i o n t o b e n e f i t from t h e R & D , i f not immediately a t l e a s t potentially, by h a v i n g a genuine and s u b s t a n t i a l interest i n the r e s u l t s which t h e r e s e a r c h might produce. 42 That i s t o say,  the R & D  activities  have  to  be  closely  43 related case  of  conferred  to the  the  s p e c i f i c needs o f the p a r t i c i p a n t s .  licensing  or conferrable  agreement, i s a key  looking  consideration.  at  the  As i n the benefits  86 J u s t i f i c a t i o n of cost incurred The  c o s t of r e s e a r c h performed a t the s p e c i f i c request  p a r t i c u l a r company should be b i l l e d t o the company and  of a  should  not  44 be  i n c l u d e d i n the c o s t i n c u r r e d ,  by l i c e n s i n g  to  unrelated  and where a MNC  parties,  those  has  amounts  receipts  should  be  45 deducted  from the c o s t .  I f t h e r e i s an excess of the  over gross c o s t s i n any year,  royalties  such excess would be d i s t r i b u t e d or  46 credited. could  Not  o n l y d i r e c t c o s t s but a l s o 47  be a l l o c a t e d ,  but s t r i c t  some  indirect  costs  i n t e r p r e t a t i o n of the n o t i o n of  r e a l b e n e f i t s i s necessary. A l l o c a t i o n o f c o s t s ( b e n e f i t s ) on a reasonable The  costs of R & D  equitable  way  to  have the  to  be  basis  allocated  participant  of  a  in  a  cost  fair  and  contribution  48 arrangement.  There i s no formula t o a l l o c a t e and MNCs have been  a l l o c a t i n g the c o s t s i n p r o p o r t i o n t o the  expected  benefit,  or  49 the  proportionate  turnover  " r u l e s o f thumb" might Canada  may  not  establishing a formula 87-2  be  of the p a r t i c i p a n t . reasonable  regard  reasonable  sales, basis  in  some  production for  sharing  Although such cases, or  cost  Revenue  profits and,  such 50  w i l l have t o be s c r u t i n i z e d by the t a x a u t h o r i t i e s .  does  preferable. appropriate  not It  specify indicates  any  basis  that  "the  of  allocating  as  IC being  method u t i l i z e d should  t o the p a r t i c u l a r circumstances  in  each  case"  suggests a p o s s i b l e approach, t h a t i s , to categorize the R & D by the l i n e of b u s i n e s s and p r o d u c t group, then t o a l l o c a t e the current expenses  as  be and  87 among t h o s e companies who p a r t i c u l a r p r o d u c t group. 51  currently  deal  i n the  Where a MNC a l l o c a t e s t h e b e n e f i t from t h i r d p a r t i e s such as royalties  f o r patents  paid  by  the t h i r d  party,  t h e same  c o n s i d e r a t i o n would have t o be g i v e n .  Arm's l e n g t h p r i n c i p l e The  cost  contribution  unrelated parties. contribution  arrangements  However,  arrangement  a r e uncommon between  t h e terms and  of  which would have been adopted  MNCs by  must  conditions  of  cost  be comparable t o those  the unrelated  parties  under  52 similar  circumstances.  F o r example,  as  t h e OECD  Report  i n d i c a t e s , i f t h e p a r t i c i p a n t o f an arrangement has not b e n e f i t e d from  R & D  concerned  over a l o n g p e r i o d o f time,  t h i s might  indicate that the R & D  was n o t c a r r i e d out i n t h e i n t e r e s t and 53 for the benefit o f t h a t p a r t i c u l a r company. Since, i n such c i r c u m s t a n c e s an independent company would n o t be l i k e l y t o 54 p a r t i c i p a t e i n t h e arrangement. The t r e a t m e n t o f p r o f i t element i n c o n t r i b u t i o n According  to  IC  87-2,  i t i s assumed  t h a t under a c o s t  s h a r i n g arrangement t h e r e s o u r c e s a r e pooled f o r economy, net c o s t s ,  and  each  convenience o r  p a r t i c i p a n t would bear i t s f a i r share o f t h e  i n r e t u r n f o r a f a i r share o f t h e u s a b l e r e s u l t s o f R  55 & D.  T h e r e f o r e , " t h e r e would be no mark-up o r p r o f i t element on  the R & D  a c t i v i t i e s " u n d e r such an arrangement.  However,  5 6  as t h e OECD  Report  indicates,  there  might  be  88  limited  room  f o r p r o f i t elements as a reward f o r t h e a c t i v i t i e s  made by t h e company which undertook t h e R & D i n o r g a n i z i n g  the  57 relevant research project. company o f a MNC, which  would  purposes, and  Where t h e d e v e l o p e r i s n o t a parent  but a s e p a r a t e l y i n c o r p o r a t e d r e s e a r c h  not use  the  results  of  the R  be  required  t o charge c o s t p l u s a p r o f i t mark-up t o r e f l e c t i t s  e f f o r t s a t o r g a n i z i n g and managing t h e r e s e a r c h . In  & D f o r i t s own  such a r e s e a r c h company would o r d i n a r i l y  allowed  entity  58  t h e case where a s e p a r a t e l y i n c o r p o r a t e d r e s e a r c h e n t i t y  o t h e r than a parent  company undertakes t h e R & D ,  Revenue Canada on t h e p r o f i t mark-up i s not recognizes  there  may  be  the a t t i t u d e of  clear.  However, i t  a case t h a t i f such an arrangement i s  o t h e r than t h e c o s t s h a r i n g arrangement, i s t r e a t e d as a p r o f i t c e n t e r ,  and t h e R & D  facility  t h e c o r p o r a t i o n which undertook R  & D a c t i v i t i e s c o u l d charge t h e amount  based  on  a  reasonable  arm's l e n g t h p r i c e which does n o t exceed Canadian t a x p a y e r ' s share o f such R & D  expense, marked up a t a reasonable  rate.  fair 59  Bona f i d e c o s t s h a r i n g arrangements IC 87-2 s t a t e s , a t t r a c t withholding "bona  fide  cost  subparagraph  "payments f o r t h e use tax."  6 0  sharing  of  R  &  D  usually  However, i f a payment i s made under a arrangement"  212(1)(d)(viii)  of  which  t h e Income  Tax  provided  in  A c t , such a  payment w i l l n o t be s u b j e c t t o P a r t X I I I t a x . Further, ("IT-3 03")  paragraph  provides  30  of  Interpretation  B u l l e t i n - 3 03  t h a t f o r a bona f i d e c o s t s h a r i n g arrangement  t o e x i s t , t h e f o l l o w i n g c o n d i t i o n s have t o be met:  89  (a) i n a d d i t i o n t o sharing research and development costs, any benefits or income r e s u l t i n g from t h a t r e s e a r c h and development must a l s o be shared; (b) such c o s t s and revenues must be shown t o have been shared on a reasonable b a s i s (the Department does not n e c e s s a r i l y regard sales, production or p r o f i t s as e s t a b l i s h i n g a reasonable b a s i s f o r s h a r i n g c o s t s ) ; (c) w h i l e o n l y a p o r t i o n of the c o s t may be charged t o the Canadian r e s i d e n t , he must r e c e i v e an i n t e r e s t i n all property or other t h i n g s of v a l u e r e s u l t i n g from the arrangement; (d) the Canadian r e s i d e n t should have t i t l e or full access t o , or a r e a l and genuine i n t e r e s t (and i n the case o f non-arm s-length t r a n s a c t i o n s generally an unrestricted i n t e r e s t ) i n , a l l p r o p e r t y or t h i n g s of value generated by the research and development, i n c l u d i n g p a t e n t s and know-how, except t h a t : 1  (i) where the non-resident does not permit the Canadian r e s i d e n t t o have t i t l e t o a patent, design, etc., the l a t t e r should have u n r e s t r i c t e d use of i t a t no a d d i t i o n a l c o s t ; and ( i i ) g e o g r a p h i c a l r e s t r i c t i o n s would be p e r m i s s i b l e so l o n g as the Canadian r e s i d e n t were e n t i t l e d t o use the p r o p e r t y i n q u e s t i o n anywhere i n Canada where he has a manufacturing or s a l e s o p e r a t i o n ; (e) double charges should not a r i s e through c h a r g i n g a taxpayer f o r a p o r t i o n of the r e s e a r c h and development costs and a l s o a r o y a l t y f o r the subsequent use of the property. It  may  involve  a  lot  of  above-mentioned c o n d i t i o n s .  But,  p a r e n t company i s  in  payments Since,  as  situated  contribution  difficulties  a  U.S.  to  cost  sharing  whereas a r o y a l t y payment i s s u b j e c t t o  t a x under the Canada-U.S. Income Tax a  "bona  fide  withholding  tax.  cost  sharing  satisfy  i t i s tempting f o r a MNC the  under  to  disguise  the  the whose  royalty  arrangement. withholding  C o n v e n t i o n , a payment under 61  arrangement" i s not s u b j e c t t o  I t should be noted t h a t ,  as paragraph 39 of  the IC  90 87-2  s t a t e s , " i f a p r o f i t element i s present,  t h e t o t a l amount o f  the payments under t h e arrangement w i l l a t t r a c t P a r t X I I I t a x . " On  t h e other  hand,  t h e OECD  Report  states  that  since  payments under c o s t c o n t r i b u t i o n arrangements a r e i n g r e d i e n t s i n 11  the c a l c u l a t i o n o f b u s i n e s s p r o f i t s and d i f f e r i n c h a r a c t e r  from  62 royalties", included,  such  should  payments,  even  i f the p r o f i t element 63 not be s u b j e c t t o w i t h h o l d i n g t a x .  is  Documentation o f arrangement In each c o s t c o n t r i b u t i o n arrangement, as s t a t e d i n IT-303, Revenue Canada  would  test the propriety of the cost sharing b a s i s by examining the value or p o t e n t i a l value of the arrangement t o t h e p a r t i c i p a n t s and by a s c e r t a i n i n g whether i t s share o f t h e t o t a l c o s t was i n l i n e w i t h the s i z e and nature o f i t s o p e r a t i o n s and whether i t i s likely t o b e n e f i t from t h e arrangement i n t h e l i g h t o f the relationship of i t s size, operations and contribution t o the s i z e , o p e r a t i o n s and c o n t r i b u t i o n o f a l l t h e c o n t r i b u t o r s taken t o g e t h e r . 64 Therefore, should  as t h e OECD Report suggests, a MNC o r p a r t i c i p a n t  d e f i n e p r e c i s e l y t h e terms  contribution advance,  arrangements  and be a b l e t o  conformity  with  and  in a  written  demonstrate  the written  conditions  that  of  the  cost  c o n t r a c t concluded i n the R  &  D  is in  agreement and has been o r w i l l be  65 c a r r i e d out taxpayer  to  i n practice. provide  Revenue  a l l t h e evidence,  concerning  other e n t i t i e s i n a  establish  that  arrangement.  such  Canada  a  group,  also  requests  including  which  the  i s necessary  arrangement i s a bona f i d e c o s t  the data to  sharing  91 I t seems t h a t the heavy burden i s imposed on the however,  considering  the  taxpayers,  p o s s i b i l i t y f o r t a x avoidance through  c o s t c o n t r i b u t i o n arrangements,  Revenue Canada's approach  might  be r e a s o n a b l e . There  is  some  criticism  circumstances" t e s t , Revenue Canada.  that despite  i t s h a r d " f a c t s and  the IRS i s more generous i n t h i s area  However, as s t a t e d b e f o r e , most parent  of l a r g e Canadian companies are s i t u a t e d i n the U.S., the R & D  a c t i v i t i e s are undertaken i n the U.S.,  the IRS d e a l s w i t h c o s t concern  is  the  amount  contribution of  contribution  companies from t h e i r f o r e i g n s u b s i d i a r i e s . Revenue  Canada,  most  of  the  cost  by  the  Canadian  taxpayers.  It  cautious  about  and most of  their  received  contribution the  when main  by t h e U.S.  On t h e c o n t r a r y ,  c o n c e r n i n g t h e d e d u c t i b i l i t y o f payments under made  companies  therefore,  arrangements,  than  cases  for are  arrangements  might be i n e v i t a b l e t h a t  w h i l e Revenue Canada  is  costs,  not pay a t t e n t i o n t o double c h a r g i n g by the  U.S.  the  IRS  may  double  p a r e n t companies t o t h e i r f o r e i g n s u b s i d i a r i e s .  deducting  of  92  SUBCHAPTER IV - FOOTNOTES  1  T r a n s f e r P r i c i n g and M u l t i n a t i o n a l E n t e r p r i s e s , Report o f the OECD Committee on F i s c a l A f f a i r s (1979), a t p a r a . 79  2  I b i d , p a r a . 81  3  I b i d , p a r a . 82  4  I b i d , p a r a . 83  5  Revenue Canada, I n t e r n a t i o n a l Transfer Pricing and Other I n t e r n a t i o n a l T r a n s a c t i o n s , I n f o r m a t i o n C i r c u l a r 87-2 (1987), a t p a r a . 42  6  I b i d , p a r a . 43  7  Porta-Svstem L i m i t e d v. 6046  8  Supra, note 5, a t p a r a . 13  9  Supra, note 1, a t p a r a . 85  10  Model Double T a x a t i o n Convention on Income and on Capital. Report o f the OECD Committee on F i s c a l A f f a i r s (1977) , a t p a r a . 12 o f the Commentary on A r t i c l e 12  11  Supra, note 1, a t para. 85  12  Supra. note 1, a t p a r a . 89  13  Supra. note 1, a t p a r a . 90  14  Supra. note 1, a t p a r a . 91  15  Supra, note 1, a t para. 92  16  Supra. note 1, a t para. 92  17  Supra. note 1, a t para. 94  18  Supra. note 1, a t p a r a . 94  19  Supra. note 5, a t p a r a . 45  20  Supra, note 1, a t p a r a . 94  21  Supra, note 1, at para. 94  Her Majesty The Queen,  (1980) D.T.C.  93  22  Supra, note 1, a t p a r a . 95  23  Supra, note 1, a t p a r a . 95  24  Supra. note 1, a t para. 96  25  Supra. note 1, a t p a r a . 95  26  Supra, note 1, a t p a r a . 96  27  Supra  28  Supra, note 1, a t para. 98  29  Supra. note 1, a t p a r a . 99  30  Supra. note 1, a t p a r a . 99  31  Supra  32  Supra. note 1, a t para. 100  33  Supra. note 1, a t para. 100  34  Supra, note 1, a t p a r a . 98 and  35  Supra. note 1, a t p a r a . 93  36  Supra. note 1, a t p a r a . 103  37  Supra. note 1, a t p a r a . 103  38  Supra. note 1, a t p a r a . 103  39  Supra. note 1, a t p a r a . 104  40  Supra, note 1, a t para. 109  41  The U.S.  42  Supra. note 5, a t p a r a . 35  43  Supra, note 1, a t para. 112  44  Supra, note 1, a t para. 105  45  Supra, note 1, a t para. 105  46  Supra, note 1, a t para. 105  47  Supra, note 1, a t para. 116  r  r  note 1, a t p a r a . 96  note 1, a t para. 100  100  IRC R e g u l a t i o n 1.482-2(d)(4)  94 48  Supra. note 1, a t p a r a . 121  49  Supra, note 1, a t p a r a . 121  50  Supra. note 1, a t p a r a . 121  51  Supra, note 5, a t p a r a . 37  52  Supra. note 1, a t p a r a . 112  53  Supra. note 1, a t p a r a . 114  54  Supra. note 1, a t p a r a . 114  55  Supra, note 5, a t p a r a . 38  56  Supra. note 5, a t p a r a . 38  57  Supra. note 1, a t p a r a . 119  58  Supra, note 1, a t p a r a . 120  59  Supra. note 5, a t p a r a . 38  60  Supra. note 5, a t p a r a . 39  61  A r t i c l e XII o f t h e Canada- U.S. Income Tax Convention  62  Supra, note 1, a t p a r a . 123  63  Supra. note 1, a t p a r a . 123  64  Revenue Canada, Income Tax A c t : Know-How and S i m i l a r Payments t o Non-Residents, Interpretation Bulletin-303 (1976), a t p a r a . 31  65  Supra, note 1, a t p a r a . 113  95  SUBCHAPTER V  CORRESPONDING ADJUSTMENT AND MUTUAL AGREEMENT PROCEDURE  1.  INTRODUCTION Where t h e  between not  transfer  price  transaction  accepted as a r e a s o n a b l e arm's l e n g t h p r i c e by Revenue Canada  country  where  the  Canada,  t h e MNC  unless  the  to  t h e primary  which  s u f f e r double t a x a t i o n .  the  i n the  adjustment  by  Revenue  Canadian t a x p a y e r belongs w i l l  S i n c e t h e f o r e i g n t a x c r e d i t system  r e l i e v e t a x p a y e r s from economic  double t a x a t i o n  a l s o cannot expect much h e l p from o t h e r authorities'  tax authority  r e l a t e d company i s s i t u a t e d does not make an  adjustment t o correspond t o  tax  intra-group  t h e Canadian taxpayer and i t s f o r e i g n r e l a t e d company i s  and an adjustment i s made,  not  i n an  discretion,  relief  domestic  will  and taxpayers provisions  from double t a x a t i o n  or  would  c o n s i d e r a b l y depend on t h e mutual agreement procedure between t h e relevant In  competent  authorities.  Canada,  the  legal  authority  f o r the corresponding  adjustment and mutual agreement procedure a d m i n i s t e r e d by Revenue Canada i s based on v a r i o u s b i l a t e r a l t a x conventions which Canada concluded Canada  and  and  the  specific  Canadian  procedures  taxpayers  t o be taken by Revenue  are provided  in  Information  C i r c u l a r 71-17R2 ("IC 71-17R2"). Since  Canada  has  adopted  the  OECD Model Double T a x a t i o n  96 Convention  ("OECD Convention")  most  "modern"  Convention,  i t would be a p p r o p r i a t e and necessary (except provided  a r e modeled  bilateral  which  otherwise  concluded  of  conventions  expressly  Canada  and  by  a  on  particular  t h e OECD where  bilateral  convention, o r t h e Income Tax A c t o r IC 71-17R2) t o i n t e r p r e t and enforce  t h e Canadian  agreement  corresponding  adjustment  and  procedure system w i t h r e f e r e n c e t o t h e OECD Convention  and i t s commentary ("OECD Commentary") and t h e OECD (i.e.,  mutual  OECD  Enterprises:  Report  "Transfer  Pricing  Three T a x a t i o n I s s u e s " ( 1 9 8 4 ) ) .  and  1984  Report  Multinational  I t would  be  also  a p p r o p r i a t e when d i s c u s s i n g t h e p r e s e n t system t o p u t emphasis on the Canada-U.S. for  Income Tax Convention  ("Canada-U.S. Convention")  t h e reason t h a t t h i s convention i s not o n l y an example o f a  t y p i c a l "modern" t a x convention modeled on but  also  problems  2.  contains  several  provisions  t h e OECD  aimed  at  Convention solving  e x p e r i e n c e d by competent a u t h o r i t i e s o f both c o u n t r i e s .  CORRESPONDING ADJUSTMENT  OECD Convention A r t i c l e 9 o f t h e OECD Convention p r o v i d e s t h a t : 1.  the  Where a) an e n t e r p r i s e o f a C o n t r a c t i n g S t a t e p a r t i c i p a t e s d i r e c t l y o r i n d i r e c t l y i n t h e management, c o n t r o l or capital o f an e n t e r p r i s e o f t h e o t h e r Contracting State, or b) t h e same persons participate directly or i n d i r e c t l y i n t h e management, c o n t r o l o r c a p i t a l o f an e n t e r p r i s e o f a C o n t r a c t i n g S t a t e and an  97 e n t e r p r i s e of the other Contracting State, and i n either case c o n d i t i o n s a r e made o r imposed between t h e two e n t e r p r i s e s i n t h e i r commercial o r f i n a n c i a l r e l a t i o n s which d i f f e r from those which would be made between independent e n t e r p r i s e s , then any p r o f i t s which would, but f o r those, c o n d i t i o n s , have accrued t o one o f t h e e n t e r p r i s e s , b u t , by reason o f those c o n d i t i o n s , have not so accrued, may be i n c l u d e d in the profits of that e n t e r p r i s e and taxed accordingly. 2. Where a C o n t r a c t i n g S t a t e i n c l u d e s i n t h e p r o f i t s of an e n t e r p r i s e o f t h a t S t a t e -and taxes a c c o r d i n g l y p r o f i t s on which an e n t e r p r i s e o f t h e o t h e r C o n t r a c t i n g S t a t e has been charged t o t a x i n t h a t o t h e r S t a t e and the profits so i n c l u d e d a r e p r o f i t s which would have accrued t o t h e e n t e r p r i s e o f t h e f i r s t - m e n t i o n e d State if t h e c o n d i t i o n s made between t h e two e n t e r p r i s e s had been those which would have been made between independent e n t e r p r i s e s , then t h a t o t h e r S t a t e s h a l l make an a p p r o p r i a t e adjustment t o t h e amount o f t h e t a x charged t h e r e i n on those p r o f i t s . In determining such adjustment, due regard shall be had t o t h e o t h e r provisions of t h i s Convention and the competent authorities of the Contracting States shall i f necessary c o n s u l t each o t h e r . Paragraph  1  states  the  "arm's l e n g t h p r i n c i p l e " and o n l y  confirms  existing p r i n c i p l e s of  the contracting  section  69 o f t h e Canadian Income Tax A c t .  s t a t e s , e.g.,  Paragraph 2 p r o v i d e s  f o r a "corresponding  adjustment";  Commentary,  t h e c o r p o r a t i o n o f S t a t e A whose p r o f i t s a r e  where  t h a t i s , a c c o r d i n g t o t h e OECD  a d j u s t e d upwards i s l i a b l e f o r t a x on an amount o f has  a l r e a d y been taxed  profit  which  i n t h e hands o f i t s a s s o c i a t e d c o r p o r a t i o n  i n S t a t e B, S t a t e B s h a l l make an a p p r o p r i a t e adjustment so as t o r e l i e v e t h e double t a x a t i o n .  1  Problem As t h e OECD 1984 Report s t a t e s , the arm's l e n g t h p r i c e under  i n t h e o r y t h e adjustment t o  paragraph  9(1)  should  create  no  98 problems  i n a r r i v i n g a t t h e amount o f r e l i e f due under paragraph  2  9(2)  and MNCs should be r e l i e v e d from double t a x a t i o n  eventually.  However, i n p r a c t i c e t h e r e a r e a number o f d i f f i c u l t i e s . the  above-mentioned  automatically  case,  a  corresponding  adjustment  In  i s not  made by S t a t e B simply because t h e p r o f i t s i n S t a t e  A have been i n c r e a s e d . The OECD 1984 Report s t a t e s : a c o r r e s p o n d i n g adjustment i s mandatory o n l y i f , and t o the extent, that t h e r e l e v a n t t a x a u t h o r i t i e s agree w i t h t h e adjustment o f t h e p r i c e made by t h e t a x authority i n the f i r s t State. 3 The  r e l i e f a v a i l a b l e under paragraph 9(2)  may not be forthcoming  i f t h e two t a x a u t h o r i t i e s have d i f f e r e n t views on a p p r o p r i a t e arm's l e n g t h p r i c e f o r a p a r t i c u l a r MNCs  have  been  complaining  about  what  i s the  transaction.  this deficiency  i n the  p r e s e n t system and have urged f o r imposing an o b l i g a t i o n on S t a t e 4  B t o comform t o t h e primary adjustment by S t a t e A. But,  as t h e OECD 1984 Report  indicates:  Imposing a simple mandatory requirement on t a x a u t h o r i t i e s t o conform a u t o m a t i c a l l y to a transfer pricing adjustment made by t h e t a x a u t h o r i t i e s o f another country, would n o t p r o t e c t MNEs against arbitrary or capricious adjustments,...providing i n t h i s way t h a t tax authorities must conform t o t h e action o f o t h e r t a x a u t h o r i t i e s over whom they have no c o n t r o l would l e a v e t h e conforming t a x a u t h o r i t i e s themselves no p r o t e c t i o n against any a r b i t r a r y o r c a p r i c i o u s adjustments... 5 In o t h e r words,  t h e t a x a u t h o r i t i e s who made t h e adjustment  i n t h e f i r s t p l a c e would be a b l e t o make a r b i t r a r y adjustments t o the  e x t e n t allowed under t h e i r domestic law and  strong  incentives  there  would  be  f o r t a x a u t h o r i t i e s t o make t r a n s f e r p r i c i n g  99 adjustments.  Therefore,  such an approach s h o u l d n o t be  adopted  i n o r d e r t o p r o t e c t t h e i n t e r e s t s o f not o n l y t h e t a x a u t h o r i t i e s but  a l s o o f t h e MNCs.  the  corresponding  I n most t r a n s f e r p r i c i n g adjustment cases, adjustment  could  be  made  through  mutual  agreement procedures.  Canada-U.S. Income Tax Convention Paragraph  9(3)  of  Canada-U.S.  Convention  provides f o r a  c o r r e s p o n d i n g adjustment: 3. Where an adjustment i s made o r t o be made by a Contracting S t a t e i n accordance w i t h paragraph 1, t h e o t h e r C o n t r a c t i n g S t a t e s h a l l ( n o t w i t h s t a n d i n g any time or p r o c e d u r a l l i m i t a t i o n s i n t h e domestic law o f t h a t o t h e r S t a t e ) make a c o r r e s p o n d i n g adjustment t o t h e income, l o s s o r t a x o f t h e r e l a t e d person i n t h a t o t h e r State i f : (a) I t agrees w i t h t h e f i r s t - m e n t i o n e d adjustment; and (b) W i t h i n s i x y e a r s from t h e end o f t h e t a x a b l e y e a r t o which the f i r s t mentioned adjustment relates, t h e competent a u t h o r i t y of the other S t a t e has been n o t i f i e d o f t h e f i r s t - m e n t i o n e d adjustment. As  s e t out  adjustment  shall  i n t h e OECD be  primary adjustment. Revenue  Canada  made  Convention,  corresponding  i f t h e o t h e r S t a t e agrees w i t h t h e  Even though t h e p r i c i n g methods u t i l i z e d  and t h e IRS a r e s i m i l a r ,  l o t of d i f f i c u l t i e s  a  t h e r e would s t i l l be a  i n r e a c h i n g an agreement  on  the  made by o t h e r t a x a u t h o r i t y r e g a r d i n g p r i n c i p l e s and Thus,  actual  relief  from  double  mutual agreement procedures between  adjustment t h e amount.  t a x a t i o n would depend on t h e t h e competent  authorities.  As mentioned b e f o r e , an automatic c o r r e s p o n d i n g adjustment should  n o t be  acceptable  to  by  both t a x a u t h o r i t i e s .  system  (The " s i x  100 y e a r s " r u l e i n subparagraph It  should  conventions equivalent example,  be  which to  noted Canada  paragraph  (b) w i l l be d e a l t that  some  concluded 9(2) o f  of do  later.)  the  " o l d " type  n o t have  t h e OECD  tax  a provision  Convention.  For  t h e Canada-Japan Income Tax Convention does not have a  p r o v i s i o n f o r c o r r e s p o n d i n g adjustments whereas A r t i c l e 4 o f t h e Convention p r o v i d e s t h e "arm's l e n g t h p r i n c i p l e " .  3.  MUTUAL AGREEMENT PROCEDURE  OECD C o n v e n t i o n Article  25  of  t h e OECD Convention p r o v i d e s f o r a "mutual  agreement procedure": 1. Where a person c o n s i d e r s t h a t t h e a c t i o n s o f one o r both o f t h e C o n t r a c t i n g S t a t e s r e s u l t or w i l l result for him i n t a x a t i o n not i n accordance with the p r o v i s i o n s o f t h i s Convention, he may, i r r e s p e c t i v e o f the remedies p r o v i d e d by t h e domestic law o f those States, p r e s e n t h i s case t o t h e competent a u t h o r i t y o f t h e C o n t r a c t i n g S t a t e o f which he i s a r e s i d e n t o r , i f h i s case comes under paragraph 1 o f A r t i c l e 24, t o t h a t of t h e C o n t r a c t i n g S t a t e o f which he i s a n a t i o n a l . The case must be p r e s e n t e d w i t h i n t h r e e y a e r s from t h e f i r s t n o t i f i c a t i o n of the action r e s u l t i n g i n taxation not in accordance with the provisions of the Convention. 2. The competent a u t h o r i t y shall endeavour, i f the objection appears t o i t t o be j u s t i f i e d and i f i t i s not i t s e l f a b l e t o a r r i v e a t a s a t i s f a c t o r y solution, to r e s o l v e t h e case by mutual agreement w i t h t h e competent a u t h o r i t y o f t h e o t h e r C o n t r a c t i n g S t a t e , w i t h a view t o t h e avoidance o f t a x a t i o n which i s not in accordance w i t h t h e Convention. Any agreement reached shall be implemented n o t w i t h s t a n d i n g any time l i m i t s i n t h e domestic law o f t h e C o n t r a c t i n g S t a t e s .  101 3. The competent a u t h o r i t i e s o f t h e C o n t r a c t i n g S t a t e s s h a l l endeavour t o r e s o l v e by mutual agreement any d i f f i c u l t i e s o r doubts a r i s i n g as t o t h e i n t e r p r e t a t i o n or application o f t h e Convention. They may a l s o consult together f o r the elimination o f t h e double t a x a t i o n i n cases n o t p r o v i d e d f o r i n t h e Convention. 4. The competent a u t h o r i t i e s o f t h e C o n t r a c t i n g S t a t e may communicate w i t h each other d i r e c t l y f o r the purpose o f r e a c h i n g an agreement i n t h e sense o f t h e p r e c e e d i n g paragraphs. When i t seems a d v i s a b l e i n o r d e r t o r e a c h agreement t o have an o r a l exchange o f opinions, such exchange may take p l a c e through a Commission consisting of representatives of the competent a u t h o r i t i e s o f t h e C o n t r a c t i n g S t a t e s . Article  25  provides  three  agreement  procedures.  The  and 2 and  applies  "taxation  provisions  first  types  of  mutual  i s d e a l t w i t h i n paragraphs 1 not  i n accordance  with  the  o f t h e Convention" and t h e taxpayer h i m s e l f i n i t i a t e s  t h i s procedure. is  to  different  The o t h e r two a r e d e a l t w i t h i n paragraph 3: one  for resolving " d i f f i c u l t i e s  and  doubts  arising  as  t o the  i n t e r p r e t a t i o n o r a p p l i c a t i o n o f t h e Convention" and t h e o t h e r i s for the  " e l i m i n a t i o n o f double t a x a t i o n i n cases not p r o v i d e d f o r i n Convention." Actual  6  mutual  agreement  procedures  concerning  transfer  7 p r i c i n g adjustments a r e those o f t h e f i r s t  type.  However, where  a p a r t i c u l a r b i l a t e r a l t a x c o n v e n t i o n does not have t h e p r o v i s i o n on t h e l i n e o f paragraph 9(2) o f t h e OECD to  a literal  Convention,  i n t e r p r e t a t i o n , as t h e OECD 1984 Report  according  indicates,  no p r o v i s i o n i n t h e c o n v e n t i o n imposes a requirement on the S t a t e which has i n c l u d e d i n i t s t a x base profits unduly t r a n s f e r r e d t o a company which i s a r e s i d e n t o f t h a t S t a t e t o r e v i s e i t s assessment i n o r d e r t o exclude such excess p r o f i t s ; taxation o f such p r o f i t s i s t h e r e f o r e n o t c o n t r a r y t o t h e c o n v e n t i o n and paragraphs 1 and 2 o f A r t i c l e 25 do not apply.8  102 In  such a case,  t h e taxpayer i n q u e s t i o n c o u l d be r e l i e v e d  from economic double t a x a t i o n by  domestic  law  or  through  the  9  exercise  of  d i s c r e t i o n a r y power by t h e t a x a u t h o r i t y ,  c o u n t r i e s e l i m i n a t e double t a x a t i o n by u t i l i z i n g o f b i l a t e r a l t a x conventions e q u i v a l e n t 25  of  t h e OECD C o n v e n t i o n .  above-mentioned provisions  1 0  the  and some provisions  t o paragraph 3 o f A r t i c l e  I n o r d e r t o a v o i d any doubt i n the  cases (where t h e c o n v e n t i o n does n o t c o n t a i n  similar  OECD Convention),  to  the  those o f paragraph 2 o f A r t i c l e 9 o f t h e  t h e OECD 1984 Report recommends  to  interpret  A r t i c l e 9 and 25 o f t h e OECD Convention as f o l l o w s : the mere f a c t t h a t c o n t r a c t i n g p a r t i e s i n s e r t e d i n t h e c o n v e n t i o n t h e t e x t o f A r t i c l e 9, as l i m i t e d t o t h e text o f paragraph 1 ... i n d i c a t e s t h a t t h e i n t e n t i o n was t o have economic double t a x a t i o n covered by t h e c o n v e n t i o n . As a r e s u l t , . . . economic double t a x a t i o n r e s u l t i n g from adjustments made t o p r o f i t s by reasons of t r a n s f e r p r i c i n g i s n o t i n accordance w i t h - a t l e a s t - t h e s p i r i t o f t h e c o n v e n t i o n and f a l l s within the scope o f t h e mutual agreement procedure s e t up under A r t i c l e 25. 11  Problems Although, procedure has  as  t h e OECD Report s t a t e s ,  been  recognized  as  an  t h e mutual  efficient  and  agreement flexible  instrument i n t h e i n t e r p r e t a t i o n ,  a p p l i c a t i o n and development o f  double  a  taxation  elimination  of  agreements both  and  suitable  means  f o r the  j u r i d i c a l and economic double t a x a t i o n ,  a  12 number o f problems have been complained by MNCs. First,  i n t h i s procedure t h e competent a u t h o r i t i e s have only  a duty t o n e g o t i a t e  and  they  a r e not r e q u i r e d  to  reach  an  103 agreement.  13  A c c o r d i n g l y t h e r e w i l l be cases where a c o r r e s p o n d i n g  adjustment w i l l not be made even though t h e competent  authorities  d i s c u s s e d t h e i s s u e u s i n g t h e mutual agreement procedure. Second, agreement,  where  t h e competent  t h e agreement  might  authorities  not be  do  reach  implemented  an  due t o 14  c o n f l i c t i n g domestic law such as example,  statutory  limits.  country  the tax authority  make  statutory  i n the  where t h e r e l a t e d company i s s i t u a t e d has a l r e a d y  f i n a l i z e d t h e computation o f t h a t company's t a x a b l e the  For  i f a t a x a u t h o r i t y i n one c o u n t r y made an adjustment on  the t r a n s f e r p r i c e o f t h e MNC a f t e r other  time  time  l i m i t had r u n out,  the corresponding 15  t a x a t i o n would remain.  adjustment  profits  and  i t i s l e g a l l y unable t o  and  unrelievable  double  Although paragraph 3 o f A r t i c l e 25 o f t h e  OECD Convention c l e a r l y p r o v i d e s , "any agreement reached s h a l l be implemented  notwithstanding  any time l i m i t s i n t h e domestic law  of t h e C o n t r a c t i n g S t a t e s " , a c c o r d i n g t o t h e OECD Commentary, T h i s p r o v i s i o n does not p r e v e n t . . . such S t a t e s as a r e not, on c o n s t i t u t i o n a l o r o t h e r l e g a l grounds, a b l e t o o v e r r u l e t h e time l i m i t s i n t h e domestic law, from inserting i n t h e mutual agreement i t s e l f such time l i m i t s as a r e adapted t o t h e i r internal statute of l i m i t a t i o n . 16 Note  that  several  countries  including  Canada  have  made  reservations that t h e implementation o f r e l i e f s and r e f u n d s f o l l o w i n g a mutual agreement ought t o remain l i n k e d t o time l i m i t s p r e s c r i b e d by t h e i r domestic laws.17 T h i r d , a c c o r d i n g t o MNCs' e x p e r i e n c e s ,  the operation of the  104 mutual  agreement procedure has been time-consuming and u n c e r t a i n 18  in i t s results. Fourth,  MNCs a l s o oppose t h e t a x a u t h o r i t i e s ' p r o p e n s i t y t o  use t h e "broad brush" approach.  That i s , t a x a u t h o r i t i e s tend t o  lump a l l c u r r e n t cases t o g e t h e r t o n e g o t i a t e a g e n e r a l s e t t l e m e n t 19 on a v e r y rough and ready b a s i s . F i f t h , MNCs complain t h a t they l a c k t h e r i g h t t o p a r t i c i p a t e 20 i n t h e procedure o t h e r than t o i n i t i a t e t h e procedure. Mandatory c o r r e s p o n d i n g adjustment (Compulsory To  system  a r b i t r a t i o n process)  e l i m i n a t e t h e above-mentioned problems,  imposing t h e o b l i g a t i o n t o reach an agreement authorities.  In  t h e view o f t h e MNCs,  MNCs have urged  on  the  competent  i f competent a u t h o r i t i e s  do n o t reach an agreement w i t h i n a c e r t a i n p e r i o d , they should be r e q u i r e d t o submit t h e case  to  supra-national  arbitrators  and  21 abide by t h e i r d e c i s i o n . As t h e MNCs p o i n t out,  t h e compulsory  would p r o v i d e MNCs w i t h complete well In and  as  arbitration  r e l i e f from double  procedure  taxation  as  t h e c e r t a i n t y o f a d e c i s i o n and t h e r e d u c t i o n o f d e l a y .  addition, argue  MNCs would be allowed t h e r i g h t t o p r e s e n t evidence i n t h e process  and  o b v i a t e t h e danger o f a "broad 22  brush" approach by t h e competent a u t h o r i t i e s . possibility  of  arbitration  a u t h o r i t i e s t o speed  up 23  would  likely  the process  and  Furthermore,  the  prompt t h e competent reach  an  agreement  q u i c k l y i n more cases. On t h e o t h e r hand, a number o f p o s s i b l e problems may a r i s e .  105 For  example,  arbitration,  to  ensure  certainty  and  the  speed o f the  i t might be necessary t o f i n a l i z e the  decision  of  24 arbitration. taxpayer  A c c o r d i n g l y , i t would be i n a p p r o p r i a t e t o a l l o w the  t o l i t i g a t e i n the domestic c o u r t s as w e l l as submit t o 25  t h e compulsory a r b i t r a t i o n procedure. r e q u i r e the taxpayer,  I t might be necessary  b e f o r e i n v o k i n g the a r b i t r a t i o n procedure,  t o exhaust o r abandon h i s domestic r i g h t o f also  be  necessary  to  to  26 appeal.  It  might  d i s a l l o w appeals a g a i n s t the d e c i s i o n of  27 arbitration.  However, MNCs may  want t o m a i n t a i n the  t o choose whichever d e c i s i o n i s advantageous also  be  necessary  b i l i t y of  a  check  to  make  on  their  to  flexibility  them.  It  might  a r b i t r a t o r s s u b j e c t t o some p o s s i activities  to  protect 28  the  tax  a u t h o r i t i e s and t a x p a y e r s from a r b i t r a r y d e c i s i o n s . Or, simple  i f the approach taken by a r b i t r a t o r s i s t o l o o k compromise,  i . e . , to  seek  middle  ground  d i f f e r e n t views p r e s e n t e d r a t h e r than an approach litigation,  the  q u i c k l y and l e s s competent  approach  between the  equivalent  from  It  would,  however,  hinder  Above  d e c i s i o n i n the l a t e r  a l l , this  to  the  conceding p o i n t s t o each o t h e r when  n e g o t i a t i n g a s o l u t i o n a t an e a r l i e r stage i n o r d e r t o 29 more advantageous  a  would produce a pragmatic r e s u l t more  expensively.  authorities  for  compulsory  obtain  a  arbitration.  arbitration  procedure  i s an  unprecedented s u r r e n d e r o f f i s c a l s o v e r e i g n t y f o r t a x a u t h o r i t i e s 30  and i s not l i k e l y t o be a c c e p t a b l e . Furthermore, transfer  price  i n the case for  where  the  MNC  manipulated  the purpose o f a v o i d i n g o r evading tax,  would be overgenerous t o p r o v i d e such a  taxpayer  with  the it  complete  106 relief  from double  After  taxation.  c o n s i d e r i n g t h e v a r i o u s a s p e c t s d i s c u s s e d above,  OECD 1984 Report d i d  not endorse  this  compulsory  the  arbitration  31 procedure. It  should  be  p o s s i b l e approaches: Affairs  to  give  noted  t h a t t h e OECD Commentary suggests two  One i s t o ask t h e OECD Committee on  Fiscal  an o p i n i o n on t h e c o r r e c t u n d e r s t a n d i n g o f the  p r o v i s i o n o f t h e OECD Convention,  and t h e o t h e r i s t o  ask the  o p i n i o n o f c e r t a i n persons chosen among t h e competent a u t h o r i t i e s 32 of  t h e OECD member c o u n t r i e s .  states,  while  they  But, as  remain  a  t h e OECD  potentially  valuable  r e s o l v i n g d i f f e r e n c e s between t a x a u t h o r i t i e s , in  1984  Report  means o f  t h e r e i s no b a s i s  e x p e r i e n c e f o r e s t i m a t i n g how f a r they may be u s e f u l f o r t h i s 33  purpose. To  sum  up  t h e OECD's  agreement procedure: above,  t h e mutual  despite  pricing  rise  to  cases.  unresolvable  a u t h o r i t i e s or leave inequitable  double  procedure  difficulties 34  t r a n s f e r p r i c i n g adjustments give  the several  agreement  instrument i n r e s o l v i n g transfer  perspective  Up  to  on t h e p r e s e n t mutual problems can be  arising  considered  a very useful  out  of  t h e p r e s e n t time,  i n the v e r y few  cases have l e d t o adjustments disputes  between  which  the relevant tax  t h e taxpayers s u f f e r i n g s i g n i f i c a n t and 35 taxation. A c c e p t a b l e compromises have i n 36  p r a c t i c e n e a r l y always been found. Most o f t h e d i f f i c u l t i e s can Convention would be unnecessary. be e l i m i n a t e d t o some e x t e n t by i n c r e a s e d e f f o r t s by competent authorities  and  taxpayers.  Therefore, 37  any changes t o t h e OECD  107 As  to  possible  f u t u r e improvements,  t h e OECD 1984 Report  made t h e f o l l o w i n g s u g g e s t i o n s .  Time l i m i t The b e s t way t o e l i m i n a t e t h e time  limit  difficulties  caused  by t h e  i s t o ensure t h a t t h e agreement reached by t h e mutual  agreement procedure o v e r r i d e s domestic time l i m i t s .  38  However, as 39  stated before,  some c o u n t r i e s a r e unable t o guarantee t h i s .  In  such cases, i n o r d e r t o minimize t h e o b s t a c l e s caused by t h e time limit,  tax  c o n s i d e r making t h e t r a n s f e r 40 p r i c i n g adjustments as e a r l y as p o s s i b l e and i f i t i s l i k e l y that an adjustment w i l l be made, t a x a u t h o r i t i e s s h o u l d n o t i f y 41 the taxpayer o f i t s i n t e n t i o n and be prepared t o e n t e r into d i s c u s s i o n pursuant t o t h e mutual agreement procedure a t as t h e earliest  authorities  stage  should  possible  i n view  of  their  administrative  42 constraints. the  time l i m i t .  provision the  I f necessary,  t h e t a x a u t h o r i t i e s s h o u l d suspend  I t might a l s o  into the b i l a t e r a l  be  appropriate  to  introduce  t a x c o n v e n t i o n which would p r o h i b i t  making o f a t r a n s f e r p r i c i n g adjustment a f t e r t h e  an agreed  period.  a  expiry  of  4 3  Time-consuming o p e r a t i o n Since  t h e mutual  complex matters which taxpayer  who  agreement  take  i s involved  a  procedure  long  with  time  to  usually  involves  unravel  and t h e  t h e procedure does not always  provide the necessary information timely,  the delay i n operation 44  of  the  procedure  i s t o some e x t e n t i n e v i t a b l e .  However,  tax  108 a u t h o r i t i e s should make improve  every  effort  to  avoid  delay  t h e i r p r a c t i c e i n s o f a r as t h e i r a d m i n i s t r a t i v e  and  to  resources  45  permit. The would  OECD 1984  help  to  Report  suggests  speed up  several  the procedure by  possible  ways.  facilitating  c a t i o n s between competent a u t h o r i t i e s through  face  to  It  communiface  or  for  the  46  telephone d i s c u s s i o n s . purpose in  of  preventing  improving  increased  The  the  exchange  tax avoidance and  cooperation  willingness  on  the  between part  to  find  information  e v a s i o n would be tax  of  r e s o l v e t r a n s f e r p r i c i n g problems and approach  of  useful  authorities.  An  the t a x a u t h o r i t i e s t o  the a d o p t i o n of  a  compromise would remove much o f the  flexible presently  47  encountered d e l a y and would  be  useful  audits against help  solve  not o n l y t o a l l o w  time  problems limits.  o f f i c i a l s a t a lower l e v e l , field,  and  would  speed  Simultaneous  examination  f o r e f f e c t i v e and  economical  i n t e r n a t i o n a l tax avoidance o r e v a s i o n but a l s o t o  the  conflicting  difficulties.  supervisory up  the  caused 4 8  The  by  delay  in  procedure  or  d e l e g a t i o n o f the d i s c u s s i o n t o  usually  the  case  officer  in  the  c o n t r o l by the c e n t r a l competent a u t h o r i t y procedure,  while also ensuring  consistent  49  decisions. Taxpayers' p a r t i c i p a t i o n Since  the  mutual  agreement  litigation  but  rather  a  competent a u t h o r i t i e s ,  procedure i s not a p r o c e s s of  process  of  discussion  between  the  competent a u t h o r i t i e s are not n e c e s s a r i l y  r e q u i r e d t o g i v e the taxpayer who  invoked the procedure the r i g h t  109 to  p r e s e n t evidence and argue i n the p r o c e e d i n g s .  practice, of  50  However,  in  the taxpayer i s normally kept informed of the progress  d i s c u s s i o n s and i s  discussion  whether  some cases,  often  asked  during  the  course  of  he can accept the s e t t l e m e n t envisaged.  the taxpayer may  be g i v e n o p p o r t u n i t i e s  to  the  51  In  present  52 relevant  facts  and arguments t o the competent a u t h o r i t i e s .  i s recommended t h a t  widely  as  i s d e s i r a b l e not o n l y f o r the t a x p a y e r s ' convenience  but  a l s o f o r t a x a u t h o r i t i e s ' convenience t o i n f o r m the taxpayers  of  possible.  such  practices  be  adopted  as  It  5 3  P u b l i c a t i o n o f i n f o r m a t i o n c o n c e r n i n g procedure It  54 the procedure t o be taken.  As s t a t e d b e f o r e ,  Revenue Canada has  i s s u e d I n f o r m a t i o n C i r c u l a r 71-17R2 and the IRS has done l i k e w i s e by i s s u i n g Revenue Procedure In  addition,  taxpayer's but the  it  has  70-18. been  case be p u b l i s h e d .  necessity  of  suggested  that  a  specific  Such p u b l i c a t i o n might be u s e f u l ,  protecting  taxpayer's a f f a i r s should be f u l l y  the  confidentiality  taken i n t o  account.  of  the  55  Conflicting court decisions Whether o r not the agreement procedure  reached  mutual  agreement  o v e r r i d e s the c o n f l i c t i n g d e c i s i o n i n a domestic c o u r t  would p r e s e n t d i f f i c u l t problems.  The r e s o l u t i o n of t h i s  depends on the domestic l e g i s l a t i o n of countries  by  each  country,  do not accept such o v e r r i d i n g . S o m e 56  problem  and  most  countries require  the taxpayer, b e f o r e i n v o k i n g the mutual agreement procedure,  to  110 exhaust o r abandon a l l domestic remedies. Commentary  states,  available  to  mutual  taxpayers  agreement  57  However,  procedures  as t h e OECD should  be  "without d e p r i v i n g them o f t h e o r d i n a r y  58 l e g a l remedies  available."  E s p e c i a l l y when t h e agreement i s not  a c c e p t a b l e f o r t h e taxpayer, appeal  to  a  domestic  e l i m i n a t e t h i s problem  t h e taxpayer s h o u l d be e n t i t l e d  court.  Therefore,  one  1  the  possibility  p o s s i b l e way t o  i s t h a t t h e taxpayer should q u i c k l y  h i s r e l a t e d company o r t h e MNC s headquarter that  a  court  alert  i n t h e o t h e r country  d e c i s i o n may a f f e c t a p o t e n t i a l  t r a n s f e r p r i c i n g i s s u e so t h a t they can invoke t h e procedure their  end.  The  treaty partners that a court  1  to  at  t a x a u t h o r i t i e s should a l s o a l e r t t h e r e l e v a n t t a x a u t h o r i t i e s i f t h e r e i s a s i g n i f i c a n t chance  decision  will  provoke  a  agreement procedure as a c o n s e q u e n c e .  request  for a  mutual  59  M N C s e f f o r t p r i o r t o t h e f o r m a l mutual agreement procedure I t might be a l e s s expensive and l e s s time-consuming f o r t h e MNC,  when  country, settle  faced  with  a  transfer  procedure  by  i t s own  is initiated.  Another  the  i n one  t h e case through n e g o t i a t i o n s w i t h t h e t a x a u t h o r i t i e s i n  adjustment  in  adjustment  t o t r y t o make a p p r o p r i a t e arrangements w i t h o r seek t o  the o t h e r c o u n t r y which would  effort  pricing  have  to  make  the  corresponding  e f f o r t b e f o r e a formal mutual agreement  6 0  important c o n s i d e r a t i o n t o be g i v e n i s t o make every  t o s e t t l e t h e case b e f o r e an i r r e v o c a b l e d e c i s i o n i s made adjusting  formalities  country  involved  6 1  and  to  keep  to  a  minimum t h e  i n t h e o p e r a t i o n s o f t h e mutual agreement  Ill procedure.  Canada-U.S. Income Tax Convention Article mutual  XXVI  agreement  of  Canada-U.S.  the  i s same a s t h a t o f  competent  authorities  n e g o t i a t e and a r e n o t r e q u i r e d t o r e a c h there  are  several  f o r t h e purpose First,  can  limitations.  p o i n t s which  of relieving  the  procedure  provides for the  procedure.  Its basic principle Accordingly,  Convention  Paragraph  have an  only  a  agreement.  duty t o However,  c a n be r e g a r d e d as improvements  t a x p a y e r s from d o u b l e  agreement  override  t h e OECD C o n v e n t i o n .  reached  domestic  by  the  time  2 of Article  mutual  limits  XXVI s t a t e s  taxation.  or  agreement procedural  that  any a g r e e m e n t r e a c h e d shall be implemented notwithstanding any time or other procedural limitations i n the domestic law o f t h e C o n t r a c t i n g S t a t e s . A l t h o u g h t h i s p r o v i s i o n does n o t a p p l y t o procedure paragraph  f o r transfer 3 of Article  pricing  the  adjustments  mutual under  agreement A r t i c l e IX,  I X a l s o p r o v i d e s i n a s i m i l a r way,  t h e o t h e r C o n t r a c t i n g S t a t e s h a l l ( n o t w i t h s t a n d i n g any time o r p r o c e d u r a l l i m i t a t i o n i n t h e domestic law o f t h a t o t h e r S t a t e ) make a c o r r e s p o n d o n g a d j u s t m e n t . Considering the fact overriding  provision  that in  Canada paragraph  made  a  reservation  2 of Article  on  the  25 o f t h e OECD  63 Convention,  the introduction  t o t h e Canada-U.S. C o n v e n t i o n Second,  o f t h e above-mentioned  provisions  i s a c o n s i d e r a b l e improvement.  t h e above-mentioned  o v e r r i d i n g p r o v i s i o n s only apply  112  the competent a u t h o r i t y o f t h e o t h e r C o n t r a c t i n g S t a t e has r e c e i v e d n o t i f i c a t i o n t h a t such a case exists within s i x years from t h e end o f t h e t a x a b l e year t o which t h e case r e l a t e s . 6 4 A r t i c l e IX a l s o s t a t e s i n a  similar  way  that  a  corresponding  adjustment w i l l be made i f t h e o t h e r S t a t e agrees w i t h t h e f i r s t mentioned adjustment and i f w i t h i n s i x y e a r s from t h e end o f t a x a b l e y e a r t o which the f i r s t - m e n t i o n e d adjustment r e l a t e s , t h e competent a u t h o r i t y o f t h e o t h e r S t a t e has been n o t i f i e d o f t h e f i r s t - m e n t i o n e d adjustment. 65 As  t h e OECD  limit the be  1984  Report  states,  t h e r e must be o b v i o u s l y some  t o t h e p e r i o d d u r i n g which c l a i m s t o r e l i e f may be made and tax l i a b i l i t y  no  certainty  taxpayers.  6 6  must become f i n a l a t some stage o r t h e r e would f o r the tax authorities  Therefore,  reasonable l i m i t a t i o n .  this  " s i x years"  Interestingly,  or rule  indeed should  for be  a  s i n c e t h e Canadian Income  Tax A c t s e t s most o f t h e time l i m i t s f o r assessment, reassessment and r e f u n d t o be s i x y e a r s ,  i t can be s a i d t h a t Canada has not  s u b s t a n t i a l l y changed i t s p o s i t i o n on t h e o v e r r i d i n g p r o v i s i o n s . Third,  i t should  unilateral relief.  be  noted  that  Article  IX  grants  an  According t o the Technical Explanation of the  Canada-U.S. Convention  ("Technical E x p l a n a t i o n " ) ,  Paragraph 4 p r o v i d e s t h a t i n a case where t h e o t h e r C o n t r a c t i n g S t a t e has not been n o t i f i e d as p r o v i d e d i n paragraph 3 [ i . e . , w i t h i n s i x y e a r s ] and i f t h e person whose income, l o s s o r t a x i s b e i n g a d j u s t e d has n o t r e c e i v e d n o t i f i c a t i o n o f t h a t adjustment w i t h i n five and o n e - h a l f years from t h e end o f i t s t a x a t i o n year t o  113 which t h e adjustment r e l a t e s , such an adjustment s h a l l not be made t o t h e extent t h a t t h e adjustment would g i v e r i s e t o double t a x a t i o n between t h e U n i t e d S t a t e s and Canada. 6 8 This provision i n fact transfer  pricing  prohibits  adjustments  tax authorities  from  making  a f t e r f i v e and o n e - h a l f y e a r s from  the end o f t a x a t i o n year and would be u s e f u l f o r m i n i m i z i n g t h e l i k e l i h o o d o f u n r e l i e v a b l e double Fourth,  the corresponding  taxation.  6 9  adjustment  and mutual agreement  procedures f o r t h e t r a n s f e r p r i c i n g adjustment the  case  of  fraud,  willful  default  or  do  not  neglect,  apply or  in  gross  70 negligence. provide  As s t a t e d b e f o r e , s i n c e i t would be overgenerous t o  complete  relief  from  double  taxation  manipulate t h e t r a n s f e r p r i c e s i n o r d e r t o a v o i d  to or  those  who  evade t a x ,  t h i s l i m i t a t i o n seems r e a s o n a b l e . In of  addition,  mutual  A r t i c l e XXVI p r o v i d e s f o r t h e same t h r e e types  agreement  procedures  graph 3 s p e c i f i e s a l i s t the  list  tion,  as t h e OECD Convention.  of subjects or potential  i s not exhaustive.  Para-  subjects,  but  A c c o r d i n g t o t h e T e c h n i c a l Explana-  competent a u t h o r i t i e s can determine t h e t a x l i a b i l i t y o f a  specific  person  that w i l l apply  or  establish rules,  generally  under  g u i d e l i n e s and procedures  t h e Convention 71  i n order  to  resolve issues f o r classes of taxpayers. As paragraph request  t o t h e r e a l t i o n s h i p w i t h domestic l i t i g a t i o n 1 of  Article  t h e mutual  XXVI  agreemnet  provides  that  procedure  procedures,  t h e taxpayer  "irrespective  may  o f the  remedies p r o v i d e d by t h e domestic law". According t o the Technical Explanation,  to  request  mutual  114 agreement procedures f o r t r a n s f e r p r i c i n g  adjustments,  72 an adjustment which " i s made o r t o be made" does n o t r e q u i r e a C o n t r a c t i n g S t a t e t o f o r m a l l y propose an adjustment b e f o r e paragraph 3 becomes p e r t i n e n t . 73 74 This  interpretation  follows  t h e OECD Commentary  and would be  u s e f u l f o r s e t t l i n g a case b e f o r e i r r e v o c a b l e d e c i s i o n s a r e made. The T e c h n i c a l E x p l a n a t i o n a l s o p r o v i d e s : The n o t i f i c a t i o n r e q u i r e d by i n paragraph 3 [of A r t i c l e IX] may be made by any o f t h e r e l a t e d persons i n v o l v e d or by t h e competent a u t h o r i t y o f t h e S t a t e which makes or i s t o make t h e i n i t i a l adjustment. 75 The  notification  required  t o be made t o t h e person t o whom t h e  i n i t i a l adjustment r e l a t e s i n paragraph 4 o f A r t i c l e IX need be  a  formal  not  adjustment but must be i n w r i t i n g and must c o n t a i n  s u f f i c i e n t d e t a i l s t o permit t h e taxpayer t o g i v e  the  notifica-  76 t i o n t o the other State.  When  comparing  t h e Canada-U.S.  Convention  w i t h t h e OECD  Convention, i t can be s a i d t h a t t h e Canada-U.S. Convention i s not o n l y modeled on OECD Convention but a l s o has t h e p r o v i s i o n s might  improve t h e d e f i c i e n c i e s i n t h e OECD  eliminate  some  of  the d i f f i c u l t i e s  a u t h o r i t i e s and MNCs. bilateral  tax  However,  conventions  Convention  experienced  i t should be which  Canada  noted  by  and may the tax  that  concluded  which  other do not  n e c e s s a r i l y have t h e same p r o v i s i o n s o r p r i n c i p l e s as t h e CanadaU.S.  Convention; f o r example, an agreement reached by t h e mutual  agreement  procedure  still  cannot i n p r i n c i p l e o v e r r i d e domestic  115 limitations.  4.  77  SPECIFIC PROCEDURES TO BE TAKEN BY REVENUE CANADA AND CANADIAN TAXPAYERS IN THE MUTUAL AGREEMENT  PROCEDURE  I n f o r m a t i o n C i r c u l a r 71-17R2 As s t a t e d b e f o r e , follow  Revenue Canada s e t out t h e procedures  to  when a person r e q u e s t s f o r t h e mutual agreement procedure  i n I n f o r m a t i o n C i r c u l a r 71-17R2. circular  aims  to  eliminate  The p o l i c y o f t h i s  t h e v a r i o u s d i f f i c u l t i e s i n mutual  agreement procedures as much as p o s s i b l e . i n p r i n c i p l e a l l o w an agreement reached by procedure  to  limitations bilateral  override  the  domestic  (except f o r t h e tax  conventions  information  S i n c e , Canada does not the  time  Canada-U.S.  mutual agreement  or other procedural  Convention)  p r o v i d e f o r time l i m i t s ,  t r i e s t o minimize o b s t a c l e s come from time l i m i t s  and  and  most  IC 71-17R2 tries  to  speed up t h e o p e r a t i o n o f t h e mutual agreement procedure.  Scope o f mutual agreement p r o c e d u r e As  paragraph  3  of  IC  71-17R2  c l e a r l y states,  not only  j u r i d i c a l but a l s o economic double t a x a t i o n would f a l l w i t h i n the scope o f t h e mutual agreement procedure by Revenue  Canada.  Requests f o r competent a u t h o r i t y c o n s i d e r a t i o n Canadian  taxpayers  can  authority consideration, i f :  make  a  request  for  competent  116  (a) t h e taxpayer has made a w r i t t e n request f o r an adjustment as a r e s u l t o f t h e a c t i o n , o r proposed action, o f a f o r e i g n government, which adjustment has been r e f u s e d , o r (b) Revenue proposes t o this action t a x a t i o n . 78  Canada, T a x a t i o n adjusts, or formally adjust, t h e incomes o f t h e taxpayer and results, or w i l l result, i n double  IC 71-17R2 r e q u i r e s t h a t requests the  foreign  the request  be made as soon as  government has f o r m a l l y proposed an adjustment" and f o r a c o r r e s p o n d i n g adjustment has  Revenue Canada.  79  Taxpayers  paragraph  who  8  been  refused  by  80 "An assessment need not have been i s s u e d . " make  a  request  consideration are required t o provide in  "should  o f IC 71-17R2.  f o r competent the  information  This information  h e l p Revenue Canada understand t h e case  and  authority specified  i s expected t o  process  the  case  speedily. Where  a r e l a t e d p a r t y o f t h e Canadian taxpayer i n a f o r e i g n  c o u n t r y i s i n v o l v e d , t h e taxpayer may i n p r a c t i c e be a d v i s e d the r e l a t e d p a r t y should  f i l e a request  f o r competent  that  authority  81 consideration  i n i t s own country.  A c c e p t a b i l i t y o f requests Paragraph request  10  of  f o r competent  IC 71-17R2 s p e c i f i e s t h e cases i n which a authority  consideration  will  not  accepted. A request will not be accepted f o r c o n s i d e r a t i o n i f : (a) t h e r e i s no t a x convention w i t h t h e f o r e i g n country involved;  be  117 (b) i t has not been r e c e i v e d w i t h i n any time limits specified i n the p a r t i c u l a r tax convention or the adjustments a r e i n y e a r s which a r e s t a t u t e - b a r r e d under s u b s e c t i o n 152(4) o f t h e Income Tax A c t ; (c) t h e i s s u e i s one t h a t t h e competent a u t h o r i t i e s o f each j u r i s d i c t i o n have agreed not t o accept (e.g. subs e c t i o n 18(4) o f t h e Income Tax A c t " t h i n - c a p i t a l i z a t i o n " cases w i t h t h e U n i t e d S t a t e s ) ; (d) t h e Canadian taxpayer was unco-operative i n d e a l i n g s w i t h Revenue Canada p e r s o n n e l d u r i n g t h e a u d i t of t h e double t a x a t i o n issues or f a i l e d t o provide information requested by t h e Canadian competent authority t o help resolve the issue; (e) t h e taxpayer has f a i l e d t o p r o v i d e t h e i n f o r m a t i o n listed i n paragraph 3 ( a ) , i n which event t h e taxpayer w i l l be asked t o supply t h e m i s s i n g i n f o r m a t i o n ; o r (f) t h e f o r e i g n government r e f u s e s case. Above a l l , the taxpayer.  subparagraph As paragraph  to  deal  with  the  (b) should be c a r e f u l l y observed by  11 o f IC 71-17R2 a l s o  states:  the Canadian taxpayer i s r e s p o n s i b l e a t a l l times f o r e n s u r i n g t h a t t h e t a x a t i o n y e a r s do n o t become s t a t u t e b a r r e d i n Canada o r t h e f o r e i g n c o u n t r y i f competent authority d i s c u s s i o n s become necessary t o a l l e v i a t e double t a x a t i o n . To  prevent  taxpayer  the taxation  should  file  years  becoming  statute-barred, the  s u i t a b l e waivers pursuant t o subparagraph 82  152(4)(a)(ii) of the companies  take  Income  Tax  Act  and  make  i t s related  necessary procedures e q u i v a l e n t t o t h e waiver i n  the r e l e v a n t f o r e i g n c o u n t r i e s . Where Revenue Canada o r t h e f o r e i g n t a x a u t h o r i t y adjustment  which  gave  rise  to  made  an  t h e double t a x a t i o n a f t e r t h e  t a x a t i o n y e a r i n t h e f o r e i g n country o r i n Canada became s t a t u t e 83 b a r r e d r e s p e c t i v e l y , t h e taxpayer can expect u n i l a t e r a l r e l i e f .  118 In  t h e case where t h e f o r e i g n t a x a u t h o r i t y  and  a  corresponding  adjustment  was  made  an  r e q u e s t e d by t h e Canadian  taxpayer t o Revenue Canada a f t e r t h e r e l e v a n t t a x a t i o n Canada  became s t a t u t e - b a r r e d ,  year c o u l d n o t be kept open, other  competent  adjustment  years i n  i f t h e t a x p a y e r can show t h a t t h e Revenue Canada  would  r e q u e s t the  a u t h o r i t y t o withdraw t h e adjustment which gave 8 4  r i s e t o t h e double t a x a t i o n . made  assessments  or  I n t h e case where  proposed  to  make  Revenue  assessments  Canada  a f t e r the  reassessment p e r i o d p r o v i d e d by t h e t a x c o n v e n t i o n o r t h e f o r e i g n s t a t u t e o f l i m i t a t i o n s has e x p i r e d , matter  of  discretion,  revise  Revenue  the  Canada  may,  as  a  Canadian adjustments t o t h e 85  e x t e n t n e c e s s a r y t o a v o i d double t a x a t i o n . Unlike Canada-U.S.  the u n i l a t e r a l Convention,  relief  provided  this relief  i n A r t i c l e IX o f  i s p r o v i d e d as a matter  of  d i s c r e t i o n by Revenue Canada o r t h e f o r e i g n t a x a u t h o r i t i e s ,  and  taxpayers s h o u l d  such  accordingly  not  expect  t o o much  from  relief. Tax a p p e a l s F o l l o w i n g t h e i d e a s o f t h e OECD Convention and t h e OECD 1984 Report,  Revenue  competent appeal  authority  the  consideration  to  exhaust  procedure i n h i s domestic c o u r t s .  states that, double  Canada does not r e q u i r e a t a x p a y e r who r e q u e s t s  problem  abandon  the  Revenue Canada c l e a r l y  when mutual agreement procedure  taxation  or  cannot  solve  the  o r t h e taxpayer r e j e c t s t h e agreement,  Canadian t a x p a y e r s t i l l has a r i g h t t o  appeal p r o c e s s t o t h e C o u r t s .  86  proceed  through  the  119 However,  i t should be noted t h a t ,  as paragraph  15  of  IC  71-17R2 s t a t e s , if t h e taxpayer chooses t o proceed w i t h t h e appeal p r o c e s s , w h i l e n e g o t i a t i o n s w i t h t h e f o r e i g n competent a u t h o r i t i e s a r e i n p r o g r e s s , these n e g o t i a t i o n s w i l l be terminated. Once a d e c i s i o n i s rendered by t h e Canadian  courts,  i t cannot be  87 changed,  and may not be e f f e c t i v e o r p e r s u a s i v e t o  competent  authorities.  the  foreign  Revenue Canada t h e r e f o r e has no room f o r  88 negotiation.  IC 71-17R2 s t a t e s :  Any f u r t h e r relief from double taxation w i l l be p o s s i b l e o n l y i f t h e f o r e i g n competent a u t h o r i t y agrees t o g r a n t such r e l i e f as a matter o f d i s c r e t i o n . 89 Where t h e mutual agreement procedure  i s being  p a r a l l e l w i t h t h e appeal process i n a c o u r t ,  proceeded  Revenue Canada w i l l  make an e f f o r t t o minimize t h e problem by s u p p l y i n g tax  a u t h o r i t i e s with d e t a i l s of,  in  the  and r a t i o n a l e f o r ,  foreign  t h e outcome  90 of  t h e appeal p r o c e s s .  However, Revenue Canada seems t o p r e f e r  not t o be i n v o l v e d w i t h such a s i t u a t i o n . The U.S. Revenue Procedure The U.S. to  be  IRS p r o v i d e s a g u i d e l i n e e x p l a i n i n g t h e  followed  by  agreement procedures The 71-17R2. useful  basic  the  IRS  and U.S.  i n Revenue Procedure  principle  However, in  70-18  of  t a x p a y e r s i n t h e mutual 70-18  the  ("RP 70-18").  RP 71-18 i s s i m i l a r t o t h a t o f IC  RP 70-18 has s e v e r a l p o i n t s  minimizing  procedure  which  would  be  v a r i o u s d i f f i c u l t i e s w i t h t h e mutual  120 agreement  procedure  and  facilitating  the  procedure  more  effectively. First, competent  the U.S. authority  taxpayer i s r e q u i r e d t o f i l e a request consideration  for  not l a t e r than 90 days a f t e r  the adjustments by the t r e a t y country are f o r m a l l y  proposed  and  91 communicated t o the r e l a t e d person. Second, taneously refunds  the  U.S.  taxpayer  who  makes a request  r e q u i r e d t o f i l e a c l a i m on Form of  agreement  any  overpayment  reached  by  the  843  o f tax t h a t may IRS  and  the  for  i s simul-  credits  be p r o v i d e d foreign  by  or the  competent  92 authority. Third, tax  where the p o s i t i o n as t o making an adjustment of  authority  of  the  t r e a t y country has  developed t o permit competent statutory or refund file  a  authority  the  not been s u f f i c i e n t l y  consideration  and  the  p e r i o d f o r f i l i n g the above-mentioned c l a i m f o r c r e d i t i s about t o e x p i r e , claim  the U.S.  f o r c r e d i t or refund  taxpayer i n q u e s t i o n  on Form 843  with  can  information  which i s r e q u i r e d i f the taxpayer f i l e s a written request for 93 competent a u t h o r i t y c o n s i d e r a t i o n . The t a x p a y e r s must keep the IRS informed as t o the proceedings of t h a t t r e a t y country and the  adjustment  being  considered,  by  filing  semi-annual  94 statements. Fourth,  the  U.S.  taxpayer  is  r e l e v a n t i n f o r m a t i o n when  submitting  competent  Above  made the  consideration. initial  adjustment,  r e q u i r e s the taxpayer t o  provide  required his  to  include  all  written  request  for  a l l , i n the case where the paragraph  5.07(k)  of  RP  IRS 70-18  121  a statement describing t h e extent (and amounts o f a l l o c a t i o n ) t h a t t h e U.S. taxpayer i s w i l l i n g t o agree t o be bound by any agreement reached by t h e competent a u t h o r i t i e s o f t h e U.S. and t h e t r e a t y country and stating t h a t he i s w i l l i n g t o enter into a c l o s i n g agreement under s e c t i o n 712 of the Code (and appropriate stipulation) consistent with such condition. Although  t h e statement  s h a l l n o t be c o n s i d e r e d t o be evidence o f 95 .  the p r o p e r amount o f t h e a l l o c a t i o n , the  IRS  when  negotiating  with  i t c o u l d be v e r y u s e f u l f o r  t h e competent a u t h o r i t y o f t h e  t r e a t y country. Fifth,  s e c t i o n 6 o f RP 70-18 r e q u i r e s t h e U.S. taxpayer t o  advise h i s r e l a t e d persons t o take such timely protective action as may be necessary w i t h f o r e i g n taxing authorities, including the staying of the expiration o f t h e p e r i o d o f l i m i t a t i o n s on t h e making o f a r e f u n d o r o t h e r t a x adjustment, complying w i t h any a p p l i c a b l e procedures of the treaty country for invoking competent authority c o n s i d e r a t i o n , and attempting to resist an adjustment or obtain an a p p r o p r i a t e c o r r e l a t i v e adjustment. Sixth,  RP  70-18  a l s o p r o v i d e s u n i l a t e r a l r e l i e f where t h e  m o d i f i c a t i o n o f t h e U.S. taxpayer's t a x l i a b i l i t y i s prevented by the o p e r a t i o n o f any law o r r u l e o f law, adjustment  cannot  be  implemented  unilateral  relief  would  be  i . e . the corresponding  by t h e time l i m i t ,  made  at  the  be  noted  discretion  but such of the  96 competent a u t h o r i t i e s . In  addition,  concerning  i t should  transfer  the Revenue Procedure request  f o r the  pricing 65-17  treatment  adjustments requires provided  the by  t h a t where t h e case i s by s e c t i o n 482 o f IRC, taxpayer  to  file  a  t h e revenue procedure  122 b e f o r e any c l o s i n g a c t i o n i s taken on t h e s e c t i o n 482 i s s u e . As  an  administrative  practice,  t h e IRS  97  recommends i t s  o f f i c i a l s t o n o t i f y t h e taxpayer a t t h e e a r l i e s t date t o i n d i c a t e the  p o s s i b i l i t y o f double t a x a t i o n ,  taken  by  n e c e s s a r y procedures  t h e taxpayer under Revenue Procedure 70-18 and 65-17,  and t h e n e c e s s i t y o f a d v i c e t o t h e t a x p a y e r ' s f o r e i g n  5.  t o be  affiliates.  SUMMING UP  I t can be s a i d t h a t t h e Canadian  corresponding  adjustment  and mutual agreement procedure systems have been u s e f u l means f o r r e l i e v i n g t a x p a y e r s from double t a x a t i o n , been  making  strenuous  difficulties  efforts  i n actual operation.  between Canada and t h e U.S., Revenue  in  Canada  practitioners,  and  and Revenue Canada has  minimizing  the  various  Up t o t h e p r e s e n t ,  due t o  good  at least  relationship  between  t h e IRS and t h e e f f o r t s o f t h e MNCs and t a x  t h e r e have  been  very  few  unrelievable  double  t a x a t i o n cases a r i s i n g from t r a n s f e r p r i c i n g adjustments. On t h e o t h e r hand, may  as t h e OECD 1984 Report i n d i c a t e s , t h e r e  be cases where MNCs u n w i l l i n g l y  Thus,  accept  t h e r e a l problems a r e not brought t o t h e s u r f a c e ,  o n l y a few u n r e l i e v a b l e double t a x a t i o n Since  the existing  cumbersome, a  t h e double t a x a t i o n .  mutual  agreement  cases  to  be  procedure  leaving reported.  i s seen  as  longwinded o r u n l i k e l y t o produce a u s e f u l r e s u l t i n  reasonable  time,  and  domestic  relief  such  c r e d i t s may m i t i g a t e t h e e f f e c t o f double t a x a t i o n .  as f o r e i g n t a x 98  However, i n  123 most cases, attempts  where Revenue Canada  to  make  a  or  a  foreign  t r a n s f e r p r i c i n g adjustment,  p r a c t i t i o n e r s have u s u a l l y been s u c c e s s f u l the  relevant  tax  tax authorities  and  authority  MNCs and t a x  i n negotiating  settling  the  case  with before  i r r e v o c a b l e d e c i s i o n s a r e made. It  i s d e s i r a b l e t h a t Canada should modernize  t a x conventions such as t h e Canada-U.S.  Convention  Canada  of  should  procedure,  improve  the  operation  i t s bilateral and  Revenue  t h e mutual agreement  e s p e c i a l l y by speeding up i t s o p e r a t i o n .  A t t h e same  time, i t i s s t r o n g l y recommended t h a t Revenue Canada and r e l e v a n t f o r e i g n competent a u t h o r i t i e s , their related parties, agreement  procedure  as w e l l as Canadian taxpayers and  s e t t l e a case b e f o r e starts.  In  this  the  context,  p r e f e r r a b l e t h a t mutual agreement procedure be used 99  resort".  formal  mutual  i t might as  a  be  "last  124  SUBCHAPTER V - FOOTNOTES  Model Double T a x a t i o n Convention on Income and on C a p i t a l . Report o f t h e OECD Committee on F i s c a l A f f a i r s (1977), a t p a r a . 2 o f t h e Commentary on A r t i c l e 9 Transfer Pricing, Corresponding Adjustments and t h e Mutual Agreement Procedure, Transfer Pricing and M u l t i n a t i o n a l Enterprises: Three T a x a t i o n I s s u e s . Report o f t h e OECD Committee on F i s c a l A f f a i r s (1984), a t p a r a . 24 3  I b i d . p a r a . 24  4  I b i d . p a r a . 25 and 41  5  I b i d . p a r a . 27  6  I b i d . p a r a . 32  7  I b i d . p a r a . 33  8  I b i d . p a r a . 76  9  I b i d . p a r a . 76  10  I b i d . p a r a . 77  11  I b i d . p a r a . 79  12  I b i d . p a r a . 40  13  I b i d . p a r a . 34  14  I b i d . p a r a . 34  15  I b i d . p a r a . 81  16  Supra, note 1, a t p a r a . 27  17  Supra, note 1/ a t para. 47  18  Supra. note 2, a t p a r a . 36  19  Supra, note 2, a t para. 36  20  Supra, note 2, a t para. 37  21  Supra, note 2, a t para. 41  125 22  Supra. note 2, a t p a r a . 42  23  Supra. note 2, a t para. 58  24  Supra, note 2, a t p a r a . 48  25  Supra  26  Supra. note 2, a t p a r a . 47  27  Supra. note 2, a t p a r a . 48  28  Supra. note 2, a t para. 48  29  Supra. note 2, a t p a r a . 51  30  Supra, note 2, a t para. 55  31  Supra. note 2, a t para. 63  32  Supra. note 1, a t p a r a . 45 of the Commentary on A r t i c l e  33  Supra. note 2, a t para. 35  34  Supra  35  Supra. note 2, a t p a r a . 56  36  Supra. note 2, a t para. 40  37  Supra. note 2, a t p a r a . 69 and  38  Supra. note 2, a t para. 82  39  Supra, note 2, a t para. 82  40  Supra. note 2, a t p a r a . 83 and  41  Supra. note 2, a t para. 86  42  Supra. note 2, a t p a r a . 89  43  Supra. note 2, a t para. 84  44  Supra. note 2, a t p a r a . 90  45  Supra. note 2, a t para. 91  46  Supra. note 2, a t para. 92  47  Supra. note 2, a t para. 93  48  Supra. note 2, a t para. 93  r  f  note 2, a t para. 47  note 2, a t p a r a . 40  72  116  25  126  49  Suora. note 2, at p a r a . 95  50  Supra. note 2, at p a r a . 98  51  Supra. note 2, at para. 100  52  Supra. note 2, at p a r a . 99  53  Supra. note 2, at para. 100  54  Supra. note 2, at p a r a . 106  55  Supra, note 2, at p a r a . 114  56  Supra, note 2, at para. 111  57  Supra  58  Supra. note 1, a t para. 6 o f  59  Supra. note 2, at p a r a . 111  60  Supra, note 2, at p a r a . 101  61  Supra. note 2, at para. 102  62  Supra. note 2, at p a r a . 113  63  Supra. note 17  64  Paragraph 2 Convention  of  A r t i c l e XXVI o f t h e Canada-U.S.  Income Tax  65  Paragraph 3 Convention  of  Article  Income Tax  66  Supra, note 2, a t p a r a . 81  67  Subparagraph 152(4)(b) and s e c t i o n 172 o f t h e Income Tax A c t  68  The T e c h n i c a l E x p l a n a t i o n on paragraph 4 o f A r t i c l e IX o f the Canada-U.S. Income Tax Convention  69  Supra. note 2, a t para. 84  70  Paragraph 5 Convention  71  The T e c h n i c a l E x p l a n a t i o n on paragraph 3 o f A r t i c l e XXVI of the Canada-U.S. Income Tax Convention  72  Paragraph  f  note 2, at para. 112  3  of  of  Article  Article  IX  IX  IX  o f t h e Canada-U.S.  o f t h e Canada-U.S.  o f t h e Canada-U.S.  Inceme Tax  Income Tax  127 Convention 73  The T e c h n i c a l E x p l a n a t i o n on paragraph 3 o f A r t i c l e IX o f the Canada-U.S. Income Tax Convention  74  Supra, note 1, a t p a r a . 11 o f the Commentary on A r t i c l e  75  Supra. note 73  76  The T e c h n i c a l E x p l a n a t i o n on paragraph 4 o f A r t i c l e IX of the Canada-U.S. Income Tax Convention  77  For example, the Canada-U.K. Income Tax Convention, which was concluded i n 1978, has n e i t h e r the p r o v i s i o n o f o v e r r i d i n g by the mutual agreement procedure, nor the p r o v i s i o n o f the c o r r e s p o n d i n g adjustment.  78  Revenue Canada, Requests f o r Competent A u t h o r i t y C o n s i d e r a t i o n - Double T a x a t i o n Issue, I n f o r m a t i o n C i r c u l a r 71-17R2 (1984), a t p a r a . 6  79  Ibid, para. 7  80  Ibid, para. 7  81  J . A. Calderwood, A Revenue Canada P e r s p e c t i v e on the Role and Method o f O p e r a t i o n o f the "Competent A u t h o r i t y " , Report of the Proceedings o f the T h i r t y - S i x t h Tax Conference. Canadian Tax Foundation (1984), a t 320  82  Supra. note 78, a t para. 11  83  Supra. note 78, a t p a r a . 12 and 13  84  Supra, note 78, a t para. 12  85  Supra. note 78, a t p a r a . 13  86  Supra. note 78, a t para. 14 and  87  Supra. note 78, a t p a r a . 15  88  Supra. note 78, a t p a r a . 16  89  Supra, note 78, a t p a r a . 15  90  Supra. note 78, a t p a r a . 15  91  The IRS, Revenue Procedure 70-18  92  I b i d , s u b s e c t i o n 4.03  93  I b i d , s u b s e c t i o n 4.05  25  16  (1970), a t s u b s e c t i o n 4.02  128  94  Ibid, subsection  4.05  95  Ibid, subsection  5.07  96  I b i d , s u b s e c t i o n s 4.08  97  Ibid  98  Supra. note 2, a t para.  57  99  Supra. note 2, a t para.  57  f  section  and  8  4.09  129  CHAPTER I I I THE JAPANESE NEW TRANSFER PRICING TAXATION SYSTEM  1.  BACKGROUND  Despite  the fact  internationalized administration period,  that  rapidly,  have  not  Japanese  economic  t h e Japanese fully  caught  t a x system up  countries. system,  transactions  with  Honest t a x p a y e r s ,  have  their  evasion  through  due t o t h e d e f i c i e n c y i n t h e t a x  had t o endure h a r s h assessments by t h e f o r e i g n t a x  Japanese government  which  and i t s  s u b s i d i a r i e s i n t a x haven  a u t h o r i t i e s and double t a x a t i o n therefrom.  In 1978,  has  y e t . For a c e r t a i n  MNCs e a s i l y committed t a x avoidance o r  intra-group  activity  Throughout a l l  this,  has been l o s i n g i t s due share o f revenue.  Japan i n t r o d u c e d  a n t i - t a x haven l e g i s l a t i o n  under  u n d i s t r i b u t e d income o f a f o r e i g n s u b s i d i a r y w i t h i t s main  o f f i c e i n "a domestic and/or  low  tax rate  corporation indirect  i s a t t r i b u t e d back  to a  i n proportion to that corporation's d i r e c t  ownership  a n t i - t a x haven l e g i s l a t i o n extent.  country"  of has  the subsidiary's proved  to  be  stock.  useful  1  This  to  some  However, t h e Japanese t a x a u t h o r i t y has not been a b l e t o  s o l v e t h e t r a n s f e r p r i c i n g problem y e t . As t h e Japanese speed profits  of  "export-oriented"  economy  increases i t s  i n t e r n a t i o n a l i z a t i o n , the p o s s i b i l i t y of s h i f t i n g of  abroad through t r a n s f e r p r i c i n g has grown.  2  As d i s c u s s e d  130 in  t h e Japanese  companies  Diet,  world-famous  ("Sogo-shoshas"),  have  Japanese  giant  trading  been p a y i n g o n l y l i t t l e  o r no  t a x i n Japan by u s i n g generous f o r e i g n t a x c r e d i t s system. In  addition,  t h e huge  fiscal  deficit  along w i t h  aggressive  assessments a g a i n s t Japanese t a x p a y e r s ,  the  subsidiaries  U.S.  s e c t i o n 482 o f t h e IRC  of  Japanese  eventually  t o be  exact,  companies by t h e IRS u s i n g  made  the  Diet  necessity of introducing transfer p r i c i n g taxation The  recent  realize  the  legislation.  l e g i s l a t i o n b i l l passed t h e D i e t on March 28,  1986 and  has been e f f e c t i v e s i n c e t h e b e g i n n i n g o f A p r i l , 1986.  2.  OVERVIEW OF THE SYSTEM  Basic provision B a s i c a l l y , t h e Japanese new t r a n s f e r p r i c i n g t a x a t i o n system is  s i m i l a r t o t h a t o f Canada,  adopts  the  t h e U.S.  arm's l e n g t h p r i n c i p l e  and other c o u n t r i e s .  and uses s i m i l a r methods f o r  f i n d i n g an arm's l e n g t h p r i c e as p r o v i d e d and t h e U.S.  IRC R e g u l a t i o n .  It  i n t h e Canadian IC 87-2  In p r i n c i p l e ,  Japan  follows  the  i d e a s o f t h e OECD r e p o r t s . The  basic  the S p e c i a l  provisions  Taxation  Paragraph  66-5(1)  are provided  in Article  66-5 o f  Measures Law ("STML"). of  the  STML  provides  that  where  a  c o r p o r a t i o n has conducted a s a l e o r purchase o f a s s e t s , p r o v i s i o n of  services  corporation,  or  other  transactions with i t s foreign a f f i l i a t e d  i f t h e amount o f  consideration  i s not  an  arm's  131 length p r i c e ,  and  the c o r p o r a t i o n , tion")  shall  i f this results in  r e d u c t i o n of the income of  the t r a n s a c t i o n ("foreign  be  deemed  to  have  affiliated  transac-  been c a r r i e d out a t an arm's  l e n g t h p r i c e f o r the purpose o f c o r p o r a t e  income t a x a t i o n of  the  4  corporation. The  p r o v i s i o n s are aimed a t o n l y c o r p o r a t i o n s which bear tax  liability  under  the  Corporation  Tax  Law  ("CTL").  Not  only  domestic c o r p o r a t i o n s but a l s o f o r e i g n c o r p o r a t i o n s which have permanent (iii)  establishment  o f the CTL)  disposition CTL)  are  in  or/and  Japan (subparagraphs 141(i)  which  have  o f immovable p r o p e r t i e s  capital  system  affiliated  is  also  only  applicable  the  to  the  "foreign  subject to t h i s rule. transaction  which  is  S i n c e the concern  only i n t e r n a t i o n a l transactions  which would r e s u l t i n r e d u c t i o n of t a x a b l e Therefore,  income  in  makes  the  equivalent  to  c a l c u l a t i o n of i t s taxable  are  a domestic t r a n s a c t i o n i n  c o r p o r a t i o n make a t r a n s a c t i o n ,  transaction  Japan  t h i s system does not apply t o a  For example, where a domestic c o r p o r a t i o n and  of a f o r e i g n a f f i l i a t e d  on i t s account and  income,  i.e.  t r a n s a c t i o n i s t o be a t t r i b u t e d t o the such  of  the  t r a n s a c t i o n s " , i . e . i n t e r n a t i o n a l t r a n s a c t i o n s between  t o p r e v e n t the revenue l o s s ,  branch  from  (subparagraph 141(iv)  p a r t i e s which are not d e a l i n g a t arm's l e n g t h .  effect.  through  included.  This  is  gains  a  the  i f that  takes i t i n t o  profit  permanent  the branch  from  the  establishment,  a t r a n s a c t i o n would not be s u b j e c t t o t h i s t r a n s f e r p r i c i n g 5 t a x a t i o n system.  132 Special  relationship  To be  11  corporation  a  foreign  must  corporation.  have  affiliated  c o r p o r a t i o n ", t h e  a " s p e c i a l r e l a t i o n s h i p " w i t h a domestic  A "special relationship"  of t h e S p e c i a l  foreign  i s d e f i n e d i n A r i c l e 39-12  T a x a t i o n Measures Law Enforcement Order  ("Enforce-  ment O r d e r " ) . Paragraph the  39-12  (1) o f t h e Enforcement Order p r o v i d e s  "special relationships"  (a) A r e l a t i o n s h i p  i n which  s h a l l be t h e f o l l o w i n g either  of  two  that  relationships:  corporations  owns,  d i r e c t l y o r i n d i r e c t l y , 50 p e r c e n t o r more o f t h e t o t a l number o f issued other  shares  o r t h e t o t a l amount o f c o n t r i b u t e d  c a p i t a l of the  corporation;  (b) A r e l a t i o n s h i p number  of  issued  i n which 50 shares  or  percent the  or  total  more  of  amount o f  the  total  contributed  c a p i t a l o f two c o r p o r a t i o n s a r e owned, d i r e c t l y o r i n d i r e c t l y , by the  same person;  (c) A r e l a t i o n s h i p  i n which e i t h e r o f  substance, determine a l l o r a p o r t i o n the  other In  corporation. the  two c o r p o r a t i o n s  can, i n  of the business p o l i c i e s of  6  case p r o v i d e d i n (a) and ( b ) , t h e d e t e r m i n a t i o n o f  d i r e c t o r i n d i r e c t ownership percentage o f a number o f shares an  amount  direct  of  contributed  ownership  capital  percentage  or  s h a l l be made by adding the  and  the  indirect  ownership  percentage. To  include  the  indirect  ownership  computation o f ownership percentage, 50  percent  or  more o f i s s u e d  percentage  into  the  t h e i n d i r e c t owner must own  shares,  e t c . of the corporation  133 which owns example,  directly  the  other  corporation  question.  For  where Company A owns 60 percent o f t h e i s s u e d shares o f  Company B and 10 p e r c e n t o f those o f Company owns  in  40  C,  and  p e r c e n t o f t h e i s s u e d shares o f Company C,  ownership percentage Accordingly  o f t h e shares o f Company C  Company  A  and  Company  B  Company A's  i s 50  percent.  Company  C  are  in  a  special  Company  C  are  in  a  special  7 relationship.  (Company  B  and  g  relationship As  as w e l l . )  long  as t h e c h a i n - r e l a t i o n s h i p i n which one c o r p o r a t i o n  owns 50 p e r c e n t o r more o f t h e i s s u e d shares, corporation  exists,  the  indirect  such a c a p i t a l a f f i l i a t e d  the i s s u e d shares,  ownership percentage  corporation  computation o f ownership percentage  e t c . o f the other  shall  be  through  included  into  o f t h e c o r p o r a t i o n which owns  etc. of that c a p i t a l a f f i l i a t e d corporations.  For example, where Company A owns 50 p e r c e n t o f t h e i s s u e d shares of Company B,  and Company B owns 50 p e r c e n t o f t h e i s s u e d shares  of Company C,  and Company C owns 50 p e r c e n t o f t h e i s s u e d shares  of Company D,  Company A and Company D a r e i n a s p e c i a l r e l a t i o n -  ship.  Where  Company D,  Company  C  owns 40 p e r c e n t o f t h e i s s u e d shares o f  i f Company A o r Company B owns 10 p e r c e n t o r more  of  the i s s u e d shares o f Company D, Company A and Company D a r e s t i l l 9  in a special  relationship.  In t h e case p r o v i d e d i n (b), i f t h e person a  number  o f shares o r an amount o f c o n t r i b u t e d c a p i t a l owned by  " i n d i v i d u a l s who individual  i s an i n d i v i d u a l ,  as  have provided  a  special i n the  C o r p o r a t i o n Tax Law a t i c l e 2 ( x ) "  1 0  relationship cabinet will  order be  with  the  prescribed  included  into  said by the  134 computation question.  of  ownership  percentage  of  the  individual  in  The s p e c i a l r e l a t i o n s h i p s i n t h i s case a r e as f o l l o w s :  (i)  the r e l a t i v e s of the i n d i v i d u a l ;  (ii)  t h e commom-law spouse o f t h e i n d i v i d u a l ;  (iii)  t h e employee o f t h e i n d i v i d u a l ;  (iv)  t h e person who i s dependent  property,  on  the i n d i v i d u a l ' s  income,  e t c . f o r support ( e x c l u d i n g those c o r r e s p o n d i n g t o a  person l i s t e d  i n ( i ) through  (iii));  (v) t h e l i v i n g - t o g e t h e r r e l a t i v e s o f person l i s t e d  i n ( i ) through  In t h e case  provided  (iii). in  r e l a t i o n s h i p i s not n e c e s s a r i l y  those  corresponding  to a  1 1  ( c ) , the existence  of  capital  required.  Arm's l e n g t h p r i c e The  concept  of  t h e arm's l e n g t h p r i n c i p l e and methods o f  c a l c u l a t i n g an arm's l e n g t h p r i c e f o l l o w s t h e OECD Report and a r e s i m i l a r t o those o f Revenue Canada's IC 87-2  and  t h e U.S.  IRC  the transactions are divided  into  Regulation. In  a p p l y i n g t h e methods,  two t y p e s :  t h e s a l e o r purchase o f i n v e n t o r y  assets  and  other  transactions. Paragraph (i) or  66-5(2) o f t h e STML p r o v i d e s t h a t :  I n t h e case where a f o r e i g n a f f i l i a t e d t r a n s a c t i o n i s a s a l e purchase  employed:  of  inventory assets,  (The method l i s t e d  t h e f o l l o w i n g methods can be  i n (d) can be employed o n l y i n t h e  case where t h e methods l i s t e d i n (a) through (a) Comparable U n c o n t r o l l e d P r i c e method:  (c) cannot be used.)  The method which uses,  135  as t h e arm's  length  amount  of  consideration  a f f i l i a t e d t r a n s a c t i o n , an amount e q u i v a l e n t consideration  which  a  special relationship, same  seller  in  the  foreign  t o t h e amount o f the  and a buyer,  who a r e not i n the  agree i n s a l e s o f i n v e n t o r y  assets  of  type as those i n t h e f o r e i g n a f f i l i a t e d t r a n s a c t i o n ,  the c i r c u m s t a n c e s such as commercial l e v e l ,  transaction  the  under volume,  s i m i l a r t o those i n t h e t r a n s a c t i o n i n q u e s t i o n ; (b) R e s a l e P r i c e Method: length  amount  of  The method which  consideration  in  uses,  the  as  the  foreign  affiliated  transaction,  an amount computed by  deducting  margin  an amount computed by  m u l t i p l y i n g the r e s a l e p r i c e  (i.e.  by a normal p r o f i t r a t i o ) , a  buyer  of  inventory  a  arm's  normal  profit  from t h e amount o f c o n s i d e r a t i o n when  assets  involved  t r a n s a c t i o n r e s e l l s those i n v e n t o r y  i n the foreign a f f i l i a t e d  a s s e t s t o a person w i t h  whom  he has no s p e c i a l r e l a t i o n s h i p ; (c) Cost P l u s Method:  The method which uses, as t h e arm's l e n g t h  amount o f c o n s i d e r a t i o n the  amount  computed  i n the  foreign  affiliated  transaction,  by adding a normal p r o f i t margin ( i . e .  amount computed by m u l t i p l y i n g t h e  amount  of  the  costs  by  an a  normal p r o f i t r a t i o ) , t o t h e amount o f t h e c o s t s o f t h e s e l l e r t o a c q u i r e by a purchase, manufacture, o r o t h e r a c t s , assets  involved  i n the f o r e i g n a f f i l i a t e d t r a n s a c t i o n ;  (d) A method s i m i l a r t o methods l i s t e d (a) through o t h e r methods p r e s c r i b e d by c a b i n e t (ii)  In t h e case where a f o r e i g n  transaction the  t h e inventory  other  than  (c) above  and  order. affiliated  transaction  a s a l e o r purchase o f i n v e n t o r y  is a assets,  f o l l o w i n g methods can be employed: (The methods l i s t e d i n (b)  136 can be employed o n l y i n t h e case where t h e methods l i s t e d i n  (a)  cannot be used.) (a)  A  method  through  which  is  equivalent  to  a method l i s t e d i n (a)  (c) above;  (b) A method which i s  equivalent  to  a  method  listed  in  (d)  , 12 above. As s t a t e d b e f o r e ,  t h e Japanese system adopted t h e "compara-  a b l e u n c o n t r o l l e d p r i c e " method,  " r e s a l e p r i c e " method and " c o s t  p l u s " method as b a s i c methods t o c a l c u l a t e an arm's l e n g t h p r i c e . While  t h e U.S.  system has t h e order o f p r i o r i t y i n a p p l i c a t i o n ,  under t h e Japanese system whichever i s t h e most r e a s o n a b l e g i v e n case can be chosen. applying  a  Necessary c o n s i d e r a t i o n t o be g i v e n i n  these methods i n an a c t u a l case i s b a s i c a l l y s i m i l a r t o  those p r o v i d e d In  in  the  where t h e r e  i n t h e OECD Report. case  of  t h e comparable u n c o n t r o l l e d p r i c e method,  i s a t r a n s a c t i o n i n which t h e i n v e n t o r y  a s s e t s of t h e  same type as those o f t h e f o r e i g n a f f i l i a t e d t r a n s a c t i o n a r e s o l d under t h e circumstances  different  from  those  of  the  foreign  a f f i l i a t e d transaction, i f i t i s possible to adjust the v a r i a t i o n in  the  amount o f c o n s i d e r a t i o n a r i s i n g due t o such d i f f e r e n c e s , 13  the comparable u n c o n t r o l l e d p r i c e method can s t i l l be used. "A normal p r o f i t r a t i o " i n t h e r e s a l e p r i c e ratio  of  deducting, in  which  t h e g r o s s p r o f i t margin,  method  i s the  ( i . e . , t h e amount computed by  from t h e t o t a l amount of revenue from t h e t r a n s a c t i o n the  r e s e l l e r purchased i n v e n t o r y  same o r s i m i l a r t o t h e i n v e n t o r y a f f i l i a t e d transaction  assets  a s s e t s which a r e the  involved i n  the  foreign  from a person w i t h whom he has no s p e c i a l  137 relationship assets  to  ("unaffiliated an u n a f f i l i a t e d  person"), person,  sells  those  t h e t o t a l amount o f c o s t s o f  the i n v e n t o r y a s s e t s i n v o l v e d i n t h e t r a n s a c t i o n ) t o mentioned  total  inventory  the  above-  amount o f revenues from t h e t r a n s a c t i o n .  Where  t h e r e a r e d i f f e r e n c e s i n t h e f u n c t i o n s performed by t h e s e l l e r o r o t h e r matters as foreign  between  affiliated  the  comparable  transaction,  transaction  i t is  necessary  and  the  to  make  adjustments t o r e f l e c t t h e v a r i a t i o n i n t h e r a t i o a r i s i n g  due t o  14 such d i f f e r e n c e s . Similarily, i s the r a t i o of  "a normal p r o f i t r a t i o " the  gross  computed by deducting, transaction,  profit  i n t h e c o s t p l u s method  margin,  (i.e.,  the  from t h e t o t a l amount o f revenues from the  i n which t h e s e l l e r a c q u i r e d i n v e n t o r y a s s e t s which  are t h e same o r s i m i l a r t o t h e i n v e n t o r y a s s e t s i n v o l v e d foreign  affiliated  unaffiliated inventory  amount  i n the  t r a n s a c t i o n , by means o f a purchase (from an  person),  manufacture o r  a s s e t s t o an u n a f f i l i a t e d  other  person,  acts,  sells  those  t h e t o t a l amount o f  costs of the inventory assets involved i n the transaction) t o the t o t a l amount o f c o s t s .  As i n t h e  resale  price  method, where  t h e r e a r e d i f f e r e n c e s i n t h e f u n c t i o n s performed by t h e s e l l e r o r other  matters  as  between  the  foreign a f f i l i a t e d transaction, ments  to  comparable  t r a n s a c t i o n and the  i t i s necessary  t o make  r e f l e c t the v a r i a t i o n i n the r a t i o a r i s i n g  adjust-  due t o such  15 differences. As  stated  above,  a v a i l a b l e o r reasonable, o t h e r methods which  are  where  none  of  these t h r e e methods are  a method s i m i l a r t o t h e t h r e e methods o r prescribed  by  cabinet  order  can  be  138 used.  1 6  The  "methods  prescribed  by c a b i n e t o r d e r "  are methods  which take an amount c a l c u l a t e d by a t t r i b u t i n g the income from purchase,  manufacture,  inventory to  the c o r p o r a t i o n  other  acts  i n question  and  relating  assets  affiliated  used  by  the  to  by,  corporation  the  transaction,  i t s foreign a f f i l i a t e d  t o the amount of expenses d i s b u r s e d  fixed  inventory  or  a s s e t s i n v o l v e d i n the f o r e i g n a f f i l i a t e d  according of  sale  or  and  the its  person values foreign  person f o r the purpose of those a c t s p e r t a i n i n g t o assets,  or other  factors  degree t o which the c o r p o r a t i o n and contributed  to  sufficient  to  presume  i t s foreign a f f i l i a t e d  the r e a l i z a t i o n of the income,  a  the the  person  as the amount of 17  consideration The  i n the f o r e i g n a f f i l i a t e d  transaction.  d i f f e r e n c e between the a c t u a l amount of c o n s i d e r a t i o n i n  a foreign a f f i l i a t e d  transaction  and  the  arm's  length  c a l c u l a t e d by the above-mentioned methods s h a l l not be for  the  purpose  b u s i n e s s y e a r of a  of  computing the 18 corporation.  Deemed F o r e i g n A f f i l i a t e d  amount  of  its  foreign  third parties.  Transaction  corporations companies  affiliated  In Japan,  transactions  by  large  o f t e n take p l a c e through g i a n t t r a n s n a t i o n a l t r a d i n g  called  in  corporation  c o r p o r a t i o n takes p l a c e through the  international  "Sogo-shoshas".  a c t i o n s are sometimes decided purchaser  deductible  income f o r the  I t o f t e n happens t h a t the t r a n s a c t i o n between a and  price  substance and  The  between  c o n d i t i o n s o f such t r a n s the  seller  and  ultimate  t h e r e f o r e the f u n c t i o n s performed by  Sogo-shoshas are so l i m i t e d t h a t the p r o f i t margin or  commission  139 r e c e i v e d by them are low. cooperate it  Realizing  with t h e i r c l i e n t s  i s h i g h l y probable that  transfer  pricing  1  that  Sogo-shoshas  usually  business or accounting s t r a t e g i e s ,  MNCs  do  avoid  t a x a t i o n by e x e c u t i n g  the  application  of  t r a n s a c t i o n s through the  t r a d i n g companies. To  plug  the  loopholes,  the Japanese  system has a s p e c i a l  p r o v i s i o n i n which a c e r t a i n t r a n s a c t i o n w i t h a t h i r d p a r t y be deemed t o be a " a f f i l i a t e d Paragraph where  a  foreign transaction".  66-5(5) o f the STML p r o v i d e s t h a t i n c e r t a i n cases  corporation  affiliated  will  conducted  a  t r a n s a c t i o n with i t s foreign  person through an u n a f f i l i a t e d person, the t r a n s a c t i o n  between the c o r p o r a t i o n and the the u n a f f i l i a t e d person s h a l l  be  19 deemed t o be a f o r e i g n a f f i l i a t e d Paragraph specific  39-12(9)  of  the  transaction. Enforcement  Order  provides  conditions:  (a) the s a l e , assignment,  l e n d i n g or p r o v i s i o n ,  between a corpo-  r a t i o n and i t s f o r e i g n a f f i l i a t e d person, o f the a s s e t s which are the  subject  of  the t r a n s a c t i o n between the c o r p o r a t i o n and the  u n a f f i l i a t e d person, or between the f o r e i g n a f f i l i a t e d person the u n a f f i l i a t e d person had a l r e a d y been decided,  pursuant t o  c o n t r a c t o r i n another manner, as o f the time the t r a n s a c t i o n conducted;  a was  and  (b) the amount of c o n s i d e r a t i o n i n the t r a n s a c t i o n i s as h a v i n g been determined, .  in  the  i n substance, between the  .  and i t s f o r e i g n a f f i l i a t e d Even  and  cases  recognized corporation  20  person. where  it  is  r e a s o n a b l e t o conduct a  t r a n s a c t i o n through an u n a f f i l i a t e d person,  i f such a case meets  140 the above-mentioned c o n d i t i o n s , the t r a n s a c t i o n w i l l be deemed t o 21 be a f o r e i g n a f f i l i a t e d The  transaction.  arm's l e n g t h p r i c e i n  transaction"  shall  be  the  the  arises  due  c o r p o r a t i o n and  to  foreign  affiliated  amount computed by making necessary  adjustments f o r the d i f f e r e n c e i n which  "deemed  the  amount  of  consideration  the f a c t t h a t the t r a n s a c t i o n between the  i t s foreign a f f i l i a t e d  corporation  is  conducted  through an u n a f f i l i a t e d person, t o the amount computed by deeming the and  t r a n s a c t i o n as h a v i n g been conducted between the 22 i t s f o r e i g n a f f i l i a t e d person.  corporation  Presumption P r o v i s i o n S i n c e most of length  price  cooperation important  are  information  needed  to  calculate  h e l d i n the taxpayer's hands,  an  the  arm's  taxpayer's  w i t h the tax a u t h o r i t i e s i n p r o v i d i n g i n f o r m a t i o n for  a f a i r and  is  reasonable a p p l i c a t i o n of the t r a n s f e r  p r i c i n g t a x a t i o n system. However, authorities i t would be  taxpayers are not always c o o p e r a t i v e and  even i f they were t o t r y t o p r o v i d e  impossible  required.  Moreover,  g e n e r a l l y speaking,  in  Japan,  tax  information,  i n those cases where i n f o r m a t i o n  t a x p a y e r ' s f o r e i g n a f f i l i a t e d person, is  w i t h the  regarding  e s p e c i a l l y p a r e n t company, the  thought t o be l a i d on  burden the  of tax  proof  is,  authority's  side. In view of the above-mentioned s i t u a t i o n s , a "presumption" p r o v i s i o n which c o n s i d e r e d o f Japanese t a x  law.  Japan  introduced  a landmark i n the  area  141 66-5(6)  Paragraph  of  t h e STML p r o v i d e s t h a t where t h e t a x  a u t h o r i t y has requested t h e c o r p o r a t i o n which  are  them  transaction,  without  delay,  i f the  length  price  computing  such an amount,  ratio prescribed thereto,  corporation  does  not  by  presuming  to  be  the  t h a t amount which i s computed by t h e r e s a l e  p r i c e method, t h e c o s t p l u s method, In  information  t h e t a x a u t h o r i t y can c o r r e c t t h e  amount o f income o f t h a t c o r p o r a t i o n , arm's  provide  necessary f o r computing t h e arm's l e n g t h p r i c e i n t h e  foreign a f f i l i a t e d provide  to  by  cabinet  o r o t h e r e q u i v a l e n t methods.  t h e gross s a l e s p r o f i t r a t i o o r a order  as  a  ratio  corresponding  o f t h e b u s i n e s s a c t i v i t y o f a c o r p o r a t i o n engaging  in a  b u s i n e s s a c t i v i t y which i s o f t h e same type as t h a t i n v o l v i n g the f o r e i g n a f f i l i a t e d t r a n s a c t i o n o f t h e c o r p o r a t i o n i n q u e s t i o n and of which t h e s c a l e o f b u s i n e s s and o t h e r contents o f i t s b u s i n e s s a c t i v i t i e s a r e s i m i l a r , w i l l be used as t h e b a s i s . The p r i c e thus c a l c u l a t e d i s presumed v a l i d and t h e taxpayer challenging  i t s v a l i d i t y has t o produce evidence t o support h i s  23 arguments. "The  gross s a l e s p r o f i t  ratio  or  a  ratio  prescribed  by  24 c a b i n e t o r d e r as a r a t i o c o r r e s p o n d i n g t h e r e t o " the  amount  of  gross  sales  profits  i s the r a t i o of  o f a c o r p o r a t i o n which i s  engaged i n a b u s i n e s s a c t i v i t y o f t h e same type and o f which  the  s c a l e o f b u s i n e s s and o t h e r contents o f i t s b u s i n e s s a c t i v i t y a r e similar,  f o r the  b u s i n e s s y e a r i n c l u d i n g t h e date on which the  f o r e i g n a f f i l i a t e d t r a n s a c t i o n was conducted  (or f o r such  period  c o r r e s p o n d i n g t h e r e t o ) , t o t h e amount o f t o t a l g r o s s revenues ( i n the case o f t h e r e s a l e p r i c e method) o r t h e amount o f t o t a l c o s t s  142 (in  t h e case o f t h e c o s t p l u s method) p e r t a i n i n g t o t h e b u s i n e s s  activity.  2 5  I t s h o u l d be based on t h e f a c t s and case  circumstances  of  each  t o determine whether t h e p a r t i c u l a r c o r p o r a t i o n i s engaging  i n a b u s i n e s s a c t i v i t y which i s o f t h e same type as t h e activity  involving  the  foreign  affiliated  business  t r a n s a c t i o n o f the  c o r p o r a t i o n and o f which t h e s c a l e o f b u s i n e s s and o t h e r contents of i t s b u s i n e s s a c t i v i t y a r e s i m i l a r o r not. S i n c e t h i s presumption  p r o v i s i o n i s unusual i n t h e  Japanese  t a x law, c o r p o r a t e taxpayers concerned t h a t t h i s p r o v i s i o n i s too a g g r e s s i v e a system.  In a d d i t i o n ,  as s t a t e d b e f o r e , i n f o r m a t i o n  r e q u i r e d by t h e t a x a u t h o r i t y might taxpayers,  and  accordingly  s h o u l d not be overburdened. Canadian  ,  not  i t is  However,  be  available  important t h a t taxpayers  c o n s i d e r i n g t h a t under t h e  Income Tax A c t t h e burden o f p r o o f i s ,  on t a x p a y e r ' s s i d e and under t h e U.S. taxpayer's burden o f p r o o f ,  f o r the  IRC,  generally,  i n addition  to  90th  day  after  by  before  t h e date o f t h e m a i l i n g o f a r e q u e s t ,  c o u r t which d e a l s w i t h t h e t a x case s h a l l p r o h i b i t t h e tion  the  i f t h e taxpayer f a i l s t o comply w i t h  the formal document r e q u e s t by t h e IRS i n i t s examination the  laid  any  introduc-  t h e taxpayer o f any f o r e i g n - b a s e d documentation  covered  26 by such  a  provision  request. is  enforcement  It  can  indispensable  be  and  said  that  reasonable  of the t r a n s f e r p r i c i n g taxation  the  presumption  f o r the e f f e c t i v e system.  P r o v i s i o n o f i n f o r m a t i o n by t a x p a y e r s In  addition  to  the  presumption  provision,  t h e Japanese  143 t r a n s f e r p r i c i n g t a x a t i o n system concerning The 66-5  s e t up  two  other  provisions  c o l l e c t i o n of information.  f i r s t one concerns f o r e i g n - b a s e d  information.  Paragraph  (7) o f t h e STML p r o v i d e s t h a t o f f i c i a l s o f t h e N a t i o n a l  Administration  may  request  i n f o r m a t i o n over which i t s custody,  a  foreign  i f i t i s necessary  corporation affiliated  to  provide  person  Tax the  maintain  f o r auditing the foreign a f f i l i a t e d  t r a n s a c t i o n between t h e c o r p o r a t i o n and  i t s foreign  affiliated  27 person. Before t h e i n t r o d u c t i o n o f t h i s p r o v i s i o n , Japanese Corporat i o n Tax Law a l r e a d y had a p r o v i s i o n i n which t h e is  authorized  taxpayer the  to  inquire  a taxpayer  tax authority  o r a person w i t h whom t h e  made a t r a n s a c t i o n and t o i n s p e c t necessary 28  taxpayer  o r t h e person.  obtain foreign-based affiliated  However,  documents o f  s i n c e i t i s important t o  i n f o r m a t i o n such as t h e l e d g e r s o f a f o r e i g n  corporation  f o r the  t r a n s f e r p r i c i n g t a x a t i o n system,  effective  enforcement  t h i s new p r o v i s i o n was  T h i s p r o v i s i o n does not impose p e n a l t i e s on t h e taxpayers cannot  or  taxpayer  do n o t p r o v i d e t h e i n f o r m a t i o n .  added. i f they  I n o t h e r words,  o n l y has t o "endeavor t o o b t a i n s a i d r e c o r d s and 29  the  books,  or  copies thereof."  for  t h e purpose o f computing t h e arm's l e n g t h p r i c e , t h e presump-  tion provision w i l l The  However,  of the  apply.  o t h e r p r o v i s i o n concerns " p e r i o d i c i n f o r m a t i o n r e t u r n s " .  Paragraph  66-5(8) o f t h e STML r e q u i r e s t h e c o r p o r a t i o n i f i t has  conducted f o r e i g n a f f i l i a t e d year,  i f such i n f o r m a t i o n i s necessary  to  transactions  during  the  business  a t t a c h a document which c o n t a i n s t h e name and l o c a t i o n  144 of  the  head  office  of  i t s foreign a f f i l i a t e d corporation  and  30 other  items t o i t s f i n a l tax r e t u r n f o r the b u s i n e s s y e a r .  C o r r e s p o n d i n g adjustment and mutual agreement procedure The  new  t r a n s f e r p r i c i n g t a x a t i o n system b i l l  p r o v i s i o n s concerning  the  corresponding  also  adjustment  includes  and  mutual  agreement procedure. Prior  to  t h i s new  legislation,  r i g h t not t o i n s e r t paragrah 9(2)  because Japan r e s e r v e d  of the OECD Convention i n t o i t s  b i l a t e r a l tax c o n v e n t i o n and most of p r e s e n t ventions  which  Japan  concluded  adjustment p r o v i s i o n s , adjustments has  the  do  bilateral  not have the  tax  con-  corresponding  the l e g a l a u t h o r i t y t o make c o r r e s p o n d i n g  been based on the i n t e r p r e t a t i o n o f the p r o v i s i o n  on the l i n e o f A r t i c l e 25 of the OECD Convention i n i t s b i l a t e r a l 31 tax  convention. The  new  legislation  w r i t t e n l e g i s l a t i v e form. ment of Tax  Treaties  States  tax  of  income  of  consideration  r e s i d e n t of Japan and taxable  Paragraph 7(1)  provides  treaties  a c t u a l amount of  c l e a r l y confirms l e g a l a u t h o r i t y i n a  that  where  Japan, in  of the Law one  Contracting  makes an adjustment on the  transaction  o f the r e s i d e n t of t h a t S t a t e ,  between  which  i f the  the a  competent  t h a t S t a t e come t o an agreement based  the p r o v i s i o n s of the tax t r e a t y w i t h r e s p e c t t o on  Enforce-  the r e s i d e n t of t h a t S t a t e when d e t e r m i n i n g  a u t h o r i t i e s of Japan and  consideration  of  for  the  taxable  the  amount  income i s determined,  D i s t r i c t D i r e c t o r s h a l l be a b l e t o c o r r e c t the amount o f  on of the  taxable  income of the r e s i d e n t of Japan t a k i n g as the b a s i s the amount of  145 consideration to  the  which i s i n t h e above-mentioned agreement,  request  f o r correction  replying  submitted  by t h a t r e s i d e n t o f  conditions  must be met:  Japan. In o t h e r words, t h e f o l l o w i n g (a) The c o u n t r y which  has  t r a n s f e r p r i c i n g adjustment of Japan and a r e s i d e n t treaty  must  have  a  tax treaty  with  i n the transaction  i n t h e country. provision  p r i n c i p l e such as paragraph as t h e p r o v i s i o n s  a  makes  a  between a r e s i d e n t  In t h i s  recognizing  Japan  case,  the  the tax  arm's  9(1) o f t h e OECD Convention  length as  well  f o r t h e mutual agreement procedure;  (b) The competent a u t h o r i t i e s o f both Japan and t h a t c o u n t r y must reach an agreement. not  impose  on  Needless t o say,  t h e competent a u t h o r i t y  c o r r e s p o n d i n g adjustment (c) The  t h e new  agreement  o r reach an agreement;  reached by  f o r correction  taxpayer  will  t h e o b l i g a t i o n t o make a  t h e competent a u t h o r i t i e s must be  accepted by t h e taxpayers and t h e r e s i d e n t request  legislation  to  t h e Japanese  o f Japan must f i l e t h e tax authority.  does n o t have t o accept t h e agreement.  of t h e agreement reached by t h e  competent  The  I f the contents  authorities  a r e not  a c c e p t a b l e t o t h e taxpayer, he can choose t o pursue r e l i e f  i n the  32 courts. Corresponding adjustments income  s h a l l be done by r e c a l c u l a t i n g t h e  u s i n g t h e r e v i s e d p r i c e which was agreed by t h e competent  a u t h o r i t i e s as t h e arm's l e n g t h p r i c e and s h a l l be made 33 past business year There  f o r the  respectively.  i s no d i f f e r e n c e  i n t h e way o f adjustments,  the cash flow c o r r e s p o n d i n g t o t h e i n i t i a l adjustment  whether  i s realized  146 or not.  However,  i n the case t h a t the taxpayer does not  the amount by which i t s income was  reduced,  such amount s h a l l  i n c l u d e d i n t o i t s r e t a i n e d e a r n i n g s and i n the case o f corporation", into i t s undistributed  return  profits.  be  "a f a m i l y  34  Procedures t o be t a k e n bv t h e t a x p a y e r t o r e q u e s t competent authority consideration A r t i c l e 12 o f M i n i s t e r i a l Ordinance Implementing Enforcement be  taken  by  authority In  of Tax T r e a t i e s p r o v i d e s the n e c e s s a r y a  taxpayer  who  makes  a  the Law f o r  procedure  request  to  f o r competent  consideration. a  prescribed  form,  the  taxpayer  must  fill  in  the  f o l l o w i n g items: (a) the name and address of i t s head o f f i c e o r p l a c e management and (b) is  of  central  control;  the f a c t s and circumstances under which the assessment not  in  accordance  which  w i t h the p r o v i s i o n o f the t a x t r e a t y  was  made o r i s g o i n g t o be made; (c)  the b u s i n e s s y e a r d u r i n g which the assessment At  the same  time,  the  taxapyer  is  relates.  required  to  attach  n e c e s s a r y documents t o the a p p l i c a t i o n . Where  an agreement i s reached between the competent author-  i t i e s and i t i s a c c e p t a b l e f o r the taxpayer, request  for  he has  to  file  a  c o r r e c t i o n w i t h i n two months from the f o l l o w i n g day 35  of the date a t which the agreement was  reached.  I t s h o u l d be noted t h a t under the Japanese  system a taxpayer  can get r e l i e f from double t a x a t i o n through c o r r e s p o n d i n g a d j u s t -  147 merits r e g a r d l e s s o f t h e o r d i n a r y s t a t u t o r y l i m i t a t i o n as l o n g the  taxpayer  has evidence  t o support h i s c l a i m .  the agreement reached by mutual domestic  time  about t h e time  limits. limits  agreement  However, on  a  request  That i s t o say,  procedures  t h e taxpayer  as  overrides  has t o be c a r e f u l  f o r competent  authority  36 consideration provided  3.  i n b i l a t e r a l tax t r e a t i e s .  ADMINISTRATIVE PRINCIPLES AND GUIDELINES  The N a t i o n a l Tax A d m i n i s t r a t i o n ' s The  National  Tax  stance  A d m i n i s t r a t i o n o f Japan ("NTA") had been  c o n s i d e r i n g t h e p r i n c i p l e s and g u i d e l i n e s t o be f o l l o w e d actual  application  o f t h e t r a n s f e r p r i c i n g t a x a t i o n system.  came t o t h e c o n c l u s i o n t h a t t h e f o l l o w i n g two be s t r i c t l y  i n the  principles  It  should  observed:  (a) To n e u t r a l i z e ,  as much as p o s s i b l e ,  the e f f e c t s of t r a n s f e r  p r i c i n g t a x a t i o n on l e g i t i m a t e economic d e c i s i o n s and a c t i v i t i e s , and  to  secure  fair  and  reasonable  assessments,  which  will  encourage t h e long-term v o l u n t a r y compliance o f t a x p a y e r s ; in this (i)  regard,  t h e concept o f t h e arm's l e n g t h p r i c e should be d e f i n e d  a reasonable  range and,  ( i i ) t o be a f a i r and reasonable backed by economic theory, cal  with  assessment,  i t should be  a n a l y s i s and a c c o u n t i n g  fully  or s t a t i s t i -  data.  (b) To minimize e x c e s s i v e and c o s t l y  administrative  burdens  on  148 taxpayers, and  while  reasonable  securing information e s s e n t i a l f o r f a i r ,  t a x adjustments.  37  F o l l o w i n g these b a s i c p r i n c i p l e s , t h e NTA w i l l p u t on t h e f o l l o w i n g areas:  just  (a) c o n f i r m a t i o n system,  emphasis  (b) c l o s e moni-  t o r i n g by t h e headquarter and (c) i n t e r n a t i o n a l c o o p e r a t i o n .  Confirmation  System  T h i s i s a system o f c o n f i r m i n g p r o p o s a l s by taxpayers price  calculation  method  and  the  of  preventing  This the  o f t r a n s f e r p r i c i n g t a x a t i o n cases which would be very  c o s t l y and time-consuming f o r both taxpayers eliminating  as  much  and t a x a u t h o r i t i e s ,  as p o s s i b l e u n c e r t a i n t i e s i n i n t e r n a t i o n a l  t r a n s a c t i o n s by s e t t i n g r u l e s o f t h e game through Under  this  system,  method o f d e t e r m i n i n g most  on t h e  required information.  system s h o u l d be i n t r o d u c e d f o r t h e purpose occurrence  38  reasonable  a  taxpayer  confirmations.  would propose t o t h e NTA a  t h e arm's l e n g t h p r i c e which he  thinks  is  and t h e scope o f t h e e s s e n t i a l i n f o r m a t i o n he i s  w i l l i n g t o provide.  The NTA w i l l then undertake in-depth  studies  on t h e economic r e a l i t y o f t h e r e l e v a n t i n d u s t r i e s .  Based on t h e  studies,  i t will  the  i f t h e NTA f i n d s t h e p r o p o s a l reasonable,  taxpayer  a sort of confirmation.  mation t o t h e taxpayer, an  informal  concurrence  To g i v e a complete c o n f i r -  t h e NTA must a t l e a s t t o g e t i n or t a c i t  from t h e r e l e v a n t f o r e i g n t a x  give  understanding  authorities.  advance  on t h e p r o p o s a l  However,  since  tax  systems and a d m i n i s t r a t i v e p r a c t i c e s may v a r y by each country, i t might  be d i f f i c u l t t o g e t such a concurrence i n advance from t h e  149 foreign tax authorities.  39  Since the t r a n s f e r p r i c i n g become  e f f e c t i v e on A p r i l  1,  taxation 1986,  legislation  had  just  t h e s p e c i f i c procedures are  s t i l l under c o n s i d e r a t i o n .  C l o s e m o n i t o r i n g bv t h e t a x a u t h o r i t y ' s headquarter According taxation  t o t h e understanding o f t h e NTA,  cases  should  be s u p e r v i s e d  transfer pricing  c l o s e l y o r taken over a t an  e a r l y stage by t h e headquarters o f t h e t a x a u t h o r i t i e s ,  so  unjustifiable  at least  until  adjustments can be prevented i n advance,  guidelines  on  transfer  pricing  taxation  are  that  firmly  e s t a b l i s h e d f o r t h e reason t h a t : (a) The t r a n s f e r p r i c i n g p r o v i s i o n i s novel and  NTA's  field  staff  requires  time  l e g i s l a t i o n f o r Japan  to  accumulate  actual  experience; (b) Other  c o u n t r i e s ' e x p e r i e n c e s show  delays  the  in  authority's  field  could  headquarter  had  have been  t h a t prolonged and c o s t l y  been  prevented  i f the tax  involved e a r l i e r ,  b e f o r e an  i r r e v o c a b l e d e c i s i o n was made; (c) T r a n s f e r p r i c i n g t a x a t i o n e n t a i l s i n t e r n a t i o n a l a s p e c t s as  such  c o r r e s p o n d i n g adjustments which a r e g e n e r a l l y handled o n l y by 40  the  headquarters. Considering  NTA's  t h a t u n l i k e t h e other  foreign  degree o f c e n t r a l i z a t i o n i s f a i r l y h i g h ,  tax authorities, and c o r p o r a t i o n s  w i t h a share c a p i t a l o f more than 100 m i l l i o n yen, which a r e most of t h e c o r p o r a t i o n s are  under  the  which make f o r e i g n  jurisdiction  of  the  affiliated audit  transactions,  department  o f the  150 r e g i o n a l t a x a t i o n bureaus, i t i s both easy and reasonable f o r t h e headquarter t o monitor those cases. Such will  monitoring  would a l s o b e n e f i t t h e taxpayer,  ensure t h e c o n s i s t e n t  also l i m i t  t h e number o f c o n t a c t  International The  application of  NTA  the  since i t  system  and  will  points.  cooperation will  make  efforts  with other tax a u t h o r i t i e s t o  e s t a b l i s h common r u l e s on t r a n s f e r p r i c i n g t a x a t i o n t o f a c i l i t a t e cooperation.  The reasons why t h e NTA c o n s i d e r s  such  efforts  to  be e s s e n t i a l a r e as f o l l o w s : (a)  The  differences  i n rules,  practices  and  between t h e t a x t r e a t y p a r t n e r s c o u l d be v e r y  interpretation  costly  and  time-  consuming f o r taxpayers as w e l l as f o r t a x a u t h o r i t i e s ; (b)  Foreign-based  information  p r i c i n g t a x a t i o n cases. basic  information  efficient  crucial  C o o p e r a t i o n based  exchange  would  be  on  in  common  helpful  transfer rules  for fair  of and  enforcement;  (c) Common partners  i s often  understanding  and  are prerequisites  close  coordination  with  treaty  f o r t h e proposed  "confirmation"  relationships  foreign  41 system. To  augment  cooperative  with  a u t h o r i t i e s , t h e NTA, has s t a r t e d semi-annual h i g h l e v e l face  meetings  and  tax  face-to-  has concluded an agreement on a simultaneous  examination program w i t h t h e U.S. IRS. A s e r i e s o f industry-wide p r i c i n g s t u d i e s w i t h IRS which can be expected e t a b l i s h m e n t o f common g u i d e l i n e s  on p r i c i n g ,  to  lead  t o the  e s p e c i a l l y on s a f e  151 haven  rules,  and  the  spontaneous  t r a n s f e r p r i c i n g cases a t an ation.  exchange  early  stage  o f i n f o r m a t i o n on  a r e under  consider-  4 2  In  addition,  t h e NTA w i l l continue  m u l t i n a t i o n a l conferences as t h e OECD, a t i o n o f Tax A d m i n i s t r a t o r s )  t o p a r t i c i p a t e i n such  t h e PATA ( P a c i f i c A s s o c i -  and t h e SGATAR (Study Group on A s i a n 43  Tax A d m i n i s t r a t i o n  and Research) meetings.  As t o t h e exchange o f i n f o r m a t i o n under the to  tax treaties, improve  the  the provisions  of  t h e NTA has been making and w i l l make e f f o r t s quality  as  well  as  the  quantity  of  the  information. P r a c t i c a l methods t o d e r i v e an arm's l e n g t h p r i c e The length  NTA  i s l o o k i n g f o r reasonable  price  difficulties experienced  at  the  administrative  of  determining  an  ways t o d e r i v e an arm's  levels.  arm's  Considering  length  i n t h e U.S. and o t h e r c o u n t r i e s ,  price  t h e NTA  already seems  come t o t h e f o l l o w i n g c o n c l u s i o n : i t i s almost i m p o s s i b l e a  "genuine"  comparable  44 price  uncontrolled  the  and  to  to find even  a  45 " s o - c a l l e d " comparable u n c o n t r o l l e d p r i c e  might n o t  always  be  46 available. way  to  I t becomes a l l t h e more important t o f i n d a f e a s i b l e  arrive  a t a reasonable  method and c o s t p l u s method. (a)  The  first  method  margin r a t i o i n t h e r e s a l e p r i c e  There a r e two methods:  i s t o average p r i c e s o f as many s i m i l a r  p r o d u c t s o r t r a n s a c t i o n s as p o s s i b l e . would  be  situations  inappropriate  and  In  this  negligent  i f the tax authority r i g i d l y  make  case,  of  actual  since i t economic  a transfer pricing  152 adjustment from  simply because t h e a c t u a l p r i c e i s s l i g h t l y d i f f e r e n t  the  single  appropriate  way  average f i g u r e . in  average would  figure  be  to  thus  arrived  at,  s e t a range c e n t e r i n g  a  more  around t h e  An examination o f t h e taxpayer would s t a r t  only  cases where an a c t u a l t r a n s a c t i o n p r i c e i s beyond t h i s range.  In o t h e r words, t h e range should be used as a t r i g g e r , and u n l e s s proved otherwise a t r a n s f e r p r i c e adjustment w i l l be made i f t h e 47 range i s exceeded; (b) The second method i s t o p i c k up a t r a n s a c t i o n most s i m i l a r t o the t r a n s a c t i o n i n q u e s t i o n ,  and d e r i v e t h e arm's  length  price  range through t h e f o l l o w i n g two s t e p s : (i) F i r s t ,  make a p p r o p r i a t e  adjustments t o account f o r q u a n t i f i -  a b l e d i f f e r e n c e s between t h e sample t r a n s a c t i o n  and  the  trans-  a c t i o n i n q u e s t i o n ; and (ii) for  Second, any  allow  a reasonable amount o f allowance t o make up  unquantifiable  but  clearly  existing  qualitative  differences. Under t h i s second method, a t r a n s f e r p r i c i n g adjustment should be made o n l y  i n a case where t h e a c t u a l p r i c e i n q u e s t i o n 48 t h i s allowance. The  above-mentioned methods f o l l o w  the  idea  i s beyond  of  t h e OECD  49 Report. In a d d i t i o n , even i n cases where one o f t h e b a s i c methods i s u t i l i z e d t o determine t h e arm's l e n g t h p r i c e , that  i t i s necessary  to  check  determined p r i c e by u s i n g o t h e r  t h e NTA  t h e reasonableness  feasible  methods  such  realizes o f the as t h e 50  r e t u r n on investment method and t h e p r o f i t a l l o c a t i o n method.  153 However, allocation  where the t a x a u t h o r i t i e s have t o use  method,  the  the  profit  c a l c u l a t i o n s h o u l d be made by thorough,  complete f u n c t i o n a l a n a l y s i s which r e f l e c t s t h e r e a l c o n t r i b u t i o n or importance o f the v a r i o u s the r e l e v a n t c o r p o r a t i o n , in  a c t i v i t i e s o r f u n c t i o n s performed by  and take i n t o account t h e  management p o l i c y o f t h e c o r p o r a t i o n  market.  4.  o r MNC  differences  and i n a n a t i o n a l  5 1  Comparison o f t h e Japanese system and Canadian system  The b a s i c s t r u c t u r e and length  price  Canadian pointed  methods  of  calculating  an  arm's  o f the Japanese system are s i m i l a r t o those o f the  system.  However,  the  following  differences  can  be  out:  Scope o f t h e p r o v i s i o n While  the  Japanese  system  only  applies  a f f i l i a t e d t r a n s a c t i o n conducted between a bears  the  to  a "foreign"  "corporation",  which  t a x l i a b i l i t y under the Japanese C o r p o r a t i o n Tax  Law,  52 and i t s f o r e i g n  affiliated  "corporation",  section  69  of  Income Tax A c t a p p l i e s t o any t r a n s a c t i o n s between p a r t i e s  the which  53 are not d e a l i n g a t arm's l e n g t h . S i n c e t h e Japanses t a x a u t h o r i t y aims w i t h  this  system  to  p r e v e n t t h e Japanese t a x p a y e r s from s h i f t i n g t h e i r income abroad, it  might be r e a s o n a b l e t o l i m i t the a p p l i c a t i o n o f t h e system t o  foreign transactions.  However,  considering  the f a c t  that  more  154 than  50 p e r c e n t o f Japanese c o r p o r a t i o n s a r e r e p o r t i n g  present,  there  liabilities  as  may a  be  the  group  possibility  of  losses at  minimizing  tax  by m a n i p u l a t i n g t h e t r a n s f e r p r i c e s i n 54  domestic  intra-group  viewpoint  of  the  transactions.  revenue  transfer pricng taxation  Accordingly,  authorities,  from  the  t h e a p p l i c a t i o n o f the  system should be  extended  to  domestic  transactions. The  reason  why  the  Ministry  of  a p p l i c a t i o n o f t h e system t o a t r a n s a c t i o n is  not  foreign  clear.  Although  affiliated  corporations  i t can  transactions  be  Finance between  limits  the  corporations  expected t h a t most o f the  are  conducted  by  and t h e magnitude o f t a x p l a n n i n g u s i n g  t o escape t h i s system a r e not s i g n i f i c a n t ,  large  individuals  I am a f r a i d t h a t  this  " d e f i c i e n c y " w i l l p r o v i d e tempting l o o p h o l e s f o r t a x p a y e r s . In  this  context,  the  Canadian  system  may  be  a  more  c o n v e n i e n t and e f f e c t i v e weapon f o r t a x a u t h o r i t i e s . D e f i n i t i o n o f "non-arm's  lenqth  While t h e Japanese system fairly  precisely  in  the  s e c t i o n 251(1) o f t h e Income "arm's other  length"  in  provisions  application  of  rather  of the  the  w  defines  "special  relationships"  STML and t h e Enforcement Order, Tax  Act  defines  a broad manner. Income  "substantial  Tax  Act  control"  the  concept  subof  T a k i n g i n t o account and  the  provision  flexible of  the  55 Enforcement Order, similar  in  terms  t h e a c t u a l e f f e c t o f both of  taxpayer's  system  might  be  p r e d i c t a b i l i t y and c e r t a i n t y .  However, t h e r e may be a l i m i t a t i o n on t h e f l e x i b l e a p p l i c a t i o n o f  155 the s u b s t a n t i a l c o n t r o l p r o v i s i o n by the NTA. virtue  of  paragraph  251(1)(b)  of the Income Tax  Canada can a p p l y s e c t i o n 69 t o any can  be  Realizing that  transactions  s a i d t h a t the Japan system should c o n t a i n  precise  definition  Revenue  theoretically, i t  p r o v i s i o n as paragraph 251(1)(b) of the Income Tax its  Act,  by  such a Act,  i s q u i t e reasonable from the  general although  taxpayer's  viewpoint.  Deemed f o r e i g n a f f i l i a t e d As  stated  above,  transactions Japan  introduced  a f f i l i a t e d transaction" provision which  taxpayers  can  to  the  plug  "deemed  the  foreign  loopholes  with  escape the a p p l i c a t i o n o f t r a n s f e r p r i c i n g  t a x a t i o n system by c o n d u c t i n g  intra-group  transactions  through  third parties. In Japan, several  most o f  corporate  large  groups.  corporations  belong  legislation,  companies. shareholding  one  of  Such a c o r p o r a t e group c o n s i s t s of a  bank, t r a d i n g company, i n s u r a n c e company, s h i p p i n g manufacturing  to  Due  to  the  company, major  Japanese  anti-monoply  companies are p r o h i b i t e d and  c a p i t a l o f each member c o r p o r a t i o n  the  share  are u s u a l l y owned by more than  twenty o t h e r members of the group and  the ownership percentage of  each member i s l e s s than 5  Accordingly,  central  management  member  corporations  However, close  and are  percent.  c o n t r o l i n the group and not  in  a  "special  members cooperate w i t h each o t h e r and  business  ("Sogo-shoshas")  relationships. perform a key  Above a l l ,  there  is  no  i n most cases, relationship".  have  considerably  trading  r o l e i n coordinating  the  companies business  156 a c t i v i t i e s of the group and most of i n t e r n a t i o n a l t r a n s a c t i o n s  of  member companies are conducted through Sogo-shoshas. Therefore, affiliated for  the  taxation  it  fair  said  that  the  deeemed  and  foreign  indispensable  e f f e c t i v e enforcement of the t r a n s f e r p r i c i n g  system.  intra-group  this  be  t r a n s a c t i o n p r o v i s i o n i s reasonable and  However,  person.  can  this  provision  transaction  Accordingly, provision  unaffiliated  by  apllies  the  case  i s conducted through "one"  a taxpayer may conducting  persons,  to  a  although  escape the  tax  an  unaffiliated  application  transaction such  where  more  than  planning  of two  might  be  cumbersome. The  Canadian  system does not have the p r o v i s i o n  t o the deemed f o r e i g n a f f i l i a t e d Canada may,  transaction  f l e x i b l e i n t e r p r e t a t i o n o f s e c t i o n 251  a n t i - a v o i d a n c e p r o v i s i o n s of the Income Tax  taxation  said  that  the  Japanese  and  other  Act.  new  l e g i s l a t i o n i s f a i r l y reasonable.  s t r u c t u r e and methods t o c a l c u l a t e s i m i l a r t o those o f Canada and the  detailed  an  the U.S.,  length  pricing the  basic  price  are  the Japanese approach i n  provisions  are  written  taxpayers'  convenience  the  p r i n c i p l e o f "no  t a x a t i o n without l a w " .  the o t h e r hand,  transfer  Although,  arm's  preferrable for  On  Revenue  UP  I t can be  which  provision.  however, cope w i t h the t r a n s f e r p r i c i n g scheme u s i n g  t h i r d p a r t i e s by  SUMMING  equivalent  into and  the  law  maintain  is the  5 6  from the v i e w p o i n t of the tax  authority,  157 although t h e presumption p r o v i s i o n i s epoch-making  i n the history  of Japanese t a x law a f t e r World War I I , i t can be s a i d t h a t Japan should  have  introduced  more g e n e r a l p r o v i s i o n s which a l l o w the  NTA more f l e x i b l e enforcement o f t h e system. I t s h o u l d be noted  that  both  the  Japanese  and  Canadian  t r a n s f e r p r i c i n g t a x a t i o n systems, u n l i k e t h e U.S. system, do not p r o v i d e f o r t h e r e a l l o c a t i o n o f income o r d e d u c t i o n among r e l a t e d entities.  158  CHAPTER I I I - FOOTNOTES  1  An O u t l i n e of Japanese Taxes 1986. o f Finance, Japan, a t 99  Tax  Bureau o f the M i n i s t r y  2  Ibid.  3  T. K i r i b u c h i , Japan's T r a n s f e r Pricincr T a x a t i o n : I n t r o d u c t i o n and Enforcement, I n t e r n a t i o n a l Tax I n s t i t u t e Seminar on T r a n s f e r P r i c i n g T a x a t i o n (1986) , a t para. 3  4  Paragraph 66-5(1) o f the STML: In the event t h a t , d u r i n g a b u s i n e s s y e a r commencing on or a f t e r A p r i l 1, 1986, a c o r p o r a t i o n has conducted the s a l e of a s s e t s , the purchase of a s s e t s , the p r o v i s i o n o f s e r v i c e s or other t r a n s a c t i o n s w i t h a f o r e i g n a f f i l i a t e d person o f s a i d corporation (meaning a foreign corporation provided in article 2 (1) ( i i ) ( h e r e a f t e r i n t h i s a r t i c l e r e f e r r e d t o as " f o r e i g n c o r p o r a t i o n " ) which has a r e l a t i o n s h i p with said corporation in which e i t h e r c o r p o r a t i o n , directly or indirectly, owns a number o f shares or an amount of contributed capital comprising 50 percent or more o f the t o t a l number of i s s u e d shares or t o t a l amount of contributed capital of the other c o r p o r a t i o n or has any o t h e r s p e c i a l r e l a t i o n s h i p with s a i d corporation as provided by cabinet order (hereafter i n t h i s article r e f e r r e d t o as " s p e c i a l relationship"); h e r e a f t e r i n t h i s a r t i c l e , the same) and, i n connection with said transaction (excluding those t r a n s a c t i o n s which g i v e r i s e t o domestic source income of said f o r e i g n a f f i l i a t e d person as l i s t e d i n C o r p o r a t i o n Tax Law a r t i c l e 141 ( i ) through ( i i i ) depending upon whether s a i d foreign affiliated person corresponds to a foreign corporation listed i n s a i d subparagraphs ( i ) through ( i i i ) and which are p r e s c r i b e d by cabinet order; hereinafter referred t o as " f o r e i g n a f f i l i a t e d t r a n s a c t i o n " ) , i f the amount of c o n s i d e r a t i o n of which payment was r e c e i v e d by s a i d c o r p o r a t i o n from s a i d f o r e i g n a f f i l i a t e d person was l e s s than an arm's l e n g t h p r i c e , o r i f the amount o f consideration which s a i d c o r p o r a t i o n p a i d t o s a i d f o r e i g n a f f i l i a t e d person was g r e a t e r than an arm's l e n g t h p r i c e , then, f o r purposes of application o f the p r o v i s i o n s of the C o r p o r a t i o n Tax Law and o t h e r laws and r e g u l a t i o n s concerning the corporation tax with regard t o the income f o r the s a i d b u s i n e s s y e a r or the l i q u i d a t i o n income ( i n c l u d i n g income o f the business year during liquidation of a corporation subject to the c o r p o r a t i o n tax on l i q u i d a t i o n income and amounts deemed t o be liquidation income due t o d i s s o l u t i o n pursuant t o the  100  159 p r o v i s i o n s o f C o r p o r a t i o n Tax Law a r t i c l e 103 ( 1 ) ( i i ) ; the same f o r paragraph (6)) due t o t h e d i s s o l u t i o n ( e x c l u d i n g d i s s o l u t i o n s pursuant t o merger; h e r e a f t e r i n t h i s article, the same), s a i d foreign a f f i l i a t e d t r a n s a c t i o n s h a l l be deemed t o have been c a r r i e d out a t an arm's l e n g t h p r i c e . ( The E n g l i s h t e x t o f t h e Japanese t r a n s f e r p r i c i n g taxation l e g i s l a t i o n i s based on t h e t r a n s l a t i o n by Mr. G. M. Thomas and Mr. K. Aramaki. ("Transfer P r i c i n g L e g i s l a t i o n " , I n t e r n a t i o n a l T a x a t i o n ( s p e c i a l i s s u e ) (1986), a t 4-23)) 5  S. Odajima, T r a n s f e r P r i c i n g T a x a t i o n , I n t e r n a t i o n a l T a x a t i o n ( s p e c i a l i s s u e ) (1986) , (Japanese t e x t ) a t 24  6  Paragraph 39-12(1) o f t h e Enforcement Order: The s p e c i a l r e l a t i o n s h i p s t o be p r o v i d e d by c a b i n e t order as p r e s c r i b e d by S p e c i a l T a x a t i o n Measures Law a r t i c l e 66-5(1) s h a l l be t h e r e l a t i o n s h i p s l i s t e d below: (i) A r e l a t i o n s h i p i n which e i t h e r o f two c o r p o r a t i o n s owns, d i r e c t l y or i n d i r e c t l y , a number o f shares o r an amount o f contributed capital comprising 50 p e r c e n t o r more o f the t o t a l number o f i s s u e d shares o r t o t a l amount o f c o n t r i b u t e d capital(hereafter i n this article called " i s s u e d shares, e t c . " ) o f t h e other c o r p o r a t i o n . ( i i ) A r e l a t i o n s h i p i n which a number o f shares o r an amount of c o n t r i b u t e d c a p i t a l comprising 50 p e r c e n t o r more o f the i s s u e d shares, e t c . o f two c o r p o r a t i o n s a r e owned, directly or indirectly, by t h e same person ( i n t h e event s a i d person i s an i n d i v i d u a l , s a i d i n d i v i d u a l and i n d i v i d u a l s who have a special r e l a t i o n s h i p w i t h s a i d i n d i v i d u a l as p r o v i d e d i n the c a b i n e t o r d e r p r e s c r i b e d by C o r p o r a t i o n Tax Law a r t i c l e 2(x)) ( e x c l u d i n g those corresponding t o a r e l a t i o n s h i p l i s t e d i n the p r e c e d i n g subparagraph). (iii) A r e l a t i o n s h i p i n which, due t o t h e e x i s t e n c e o f the f a c t s l i s t e d below o r o t h e r f a c t s s i m i l a r t h e r e t o , e i t h e r of two c o r p o r a t i o n s can, i n substance, determine a l l o r a p o r t i o n of the business p o l i c i e s of the other corporation ( e x c l u d i n g those corresponding to a relationship l i s t e d i n the p r e c e d i n g two subparagraphs). (a) An o f f i c e r w i t h a u t h o r i t y t o r e p r e s e n t , o r one h a l f o f more o f t h e o f f i c e r s o f , s a i d other c o r p o r a t i o n ( i s ) / [ a r e ] (a) person[s] who ( i s ) / [ a r e ] c o n c u r r e n t l y employed as (an) o f f i c e r [ s ] o r employee[s] o f t h e s a i d c o r p o r a t i o n o r (a) person[s] who (was)/[were] (an) o f f i c e r [ s ] o r employee[s] of s a i d corporation. (b) S a i d o t h e r c o r p o r a t i o n conducts a c o n s i d e r a b l e portion of i t s business a c t i v i t i e s i n r e l i a n c e upon t r a n s a c t i o n s with said corporation. (c) S a i d o t h e r c o r p o r a t i o n procures a c o n s i d e r a b l e portion of the funds which a r e necessary f o r i t s business a c t i v i t i e s by means o f borrowing from s a i d corporation or by r e c e i v i n g t h e guarantees o f s a i d c o r p o r a t i o n .  7  Paragraph 39-12(2) o f t h e Enforcement Order  160  8  Subparagraph 3 9 - 1 2 ( 1 ) ( i i )  of the Enforcement Order  9  Subparagraph 3 9 - 1 2 ( 3 ) ( i i )  of the Enforcement Order  10  Subparagraph 3 9 - 1 2 ( 1 ) ( i i )  of the Enforcement Order  11  Paragraph 4(11)  12  Paragraph 66-5(2) of the STML: The arm's l e n g t h p r i c e p r o v i d e d i n the p r e c e d i n g paragraph s h a l l mean the amount which i s computed i n accordance w i t h a method l i s t e d i n the f o l l o w i n g subparagraphs, depending upon whether the f o r e i g n a f f i l i a t e d t r a n s a c t i o n corresponds t o the t r a n s a c t i o n l i s t e d i n the f o l l o w i n g subparagraphs: (i) Sale o r purchase o f inventory assets prescribed in Corporation Tax Law a r i c l e 2 ( x x i ) ( h e r e a f t e r r e f e r r e d t o as "inventory a s s e t s " ) : the f o l l o w i n g methods (the methods listed in (d) can be employed o n l y i n the case t h a t the methods l i s t e d i n (a) through (c) cannot be used): (a) Comparable u n c o n t r o l l e d p r i c e method (meaning the method which uses, as the amount of c o n s i d e r a t i o n i n s a i d f o r e i g n a f f i l i a t e d transaction, an amount e q u i v a l e n t t o the amount o f c o n s i d e r a t i o n i n a t r a n s a c t i o n i n which a s e l l e r and a buyer who were not i n a s p e c i a l r e l a t i o n s h i p engaged i n s a l e s of i n v e n t o r y a s s e t s which were of the same type as the inventory assets involved i n said foreign a f f i l i a t e d transaction, under circumstances such as commercial l e v e l , transaction volume, and o t h e r circumstances which were s i m i l a r t o those i n s a i d f o r e i g n a f f i l i a t e d transaction including the amount of consideration a f t e r making adjustments, i n the event t h a t t h e r e i s a t r a n s a c t i o n in which s a i d inventory assets o f the same type were s o l d under c i r c u m s t a n c e s i n which t h e r e were d i f f e r e n c e s from said foreign a f f i l i a t e d t r a n s a c t i o n i n commercial l e v e l , t r a n s a c t i o n volume, and o t h e r such circumstances and i t i s possible to adjust the v a r i a t i o n i n the amount of c o n s i d e r a t i o n a r i s i n g due t o such d i f f e r e n c e s ) ) . (b) R e s a l e p r i c e method (meaning the method which uses, as the amount of consideration in said foreign a f f i l i a t e d transaction, an amount computed by deducting, from the amount of consideration f o r which a buyer of i n v e n t o r y assets involved i n a foreign a f f i l i a t e d transaction sold said inventory assets to a person w i t h which i t had no s p e c i a l r e l a t i o n s h i p ( h e r e a f t e r i n t h i s paragraph referred t o as the " r e s a l e p r i c e " ) , a normal p r o f i t margin (meaning an amount computed by m u l t i p l y i n g s a i d r e s a l e p r i c e by a normal p r o f i t r a t i o p r e s c r i b e d by c a b i n e t o r d e r ) ) . (c) Cost p l u s method (meaning the method which uses, as the amount of consideration in said foreign affiliated transaction, the amount computed by adding, t o the amount of the costs of the seller to acquire by purchase, manufacture, o r o t h e r a c t s the i n v e n t o r y a s s e t s i n v o l v e d i n  of the C o r p o r a t i o n  Tax  Law  Enforcement Order  161 s a i d f o r e i g n a f f i l i a t e d t r a n s a c t i o n , a normal p r o f i t margin (meaning an amount computed by m u l t i p l y i n g s a i d amount o f c o s t s by a normal p r o f i t ratio p r e s c r i b e d by c a b i n e t order)). (d) A method s i m i l a r t o t h e methods l i s t e d i n (a) through (c) above and o t h e r methods p r e s c r i b e d by c a b i n e t order, (ii) T r a n s a c t i o n s o t h e r than those l i s t e d i n t h e p r e c e d i n g subparagraph: The methods l i s t e d below (the method l i s t e d i n (b) can be employed o n l y i n t h e case t h a t t h e method l i s t e d i n (a) cannot be u s e d ) : (a) A method which i s e q u i v a l e n t t o a method l i s t e d i n (a) through (c) i n t h e p r e c e d i n g subparagraph. (b) A method which i s e q u i v a l e n t t o a method l i s t e d i n (d) of t h e p r e c e d i n g subparagraph. 13  Subaragraph 66-5(2)(1)(a) o f t h e STML  14  Paragraph 39-12(6) o f t h e Enforcement Order  15  Paragraph 39-12(7) o f t h e Enforcement Order  16  Subparagraph 6 6 - 5 ( 2 ) ( i ) o f t h e STML  17  Paragraph 39-12(8) o f t h e Enforcement Order  18  Paragraphs 66-5(3) and (4) o f t h e STML  19  Paragraph 66-5(5) o f t h e STML: In a case p r e s c r i b e d by c a b i n e t o r d e r as a case i n which a c o r p o r a t i o n has conducted a t r a n s a c t i o n w i t h a f o r e i g n affiliated person o f s a i d c o r p o r a t i o n through another person (excluding another f o r e i g n affiliated person of said corporation o r a domestic c o r p o r a t i o n which has a s p e c i a l r e l a t i o n s h i p w i t h s a i d f o r e i g n a f f i l i a t e d person: h e r e i n a f t e r referred t o as " u n a f f i l i a t e d person"), the transaction between s a i d c o r p o r a t i o n and s a i d u n a f f i l i a t e d p e r s o n s h a l l be deemed t o be a f o r e i g n affiliated transaction and t h e p r o v i s i o n s o f paragraph (1) s h a l l be a p p l i e d a c c o r d i n g l y .  20  Paragraph 39-12(9) o f t h e Enforcement Order  21  Supra, note 5, a t p a r a . 38  22  Paragraph 39-12(10) o f t h e Enforcement Order  23  Supra. note 5, a t 38  24  Paragraph 66-5(6) o f t h e STML  25  Paragraph 39-12(11) o f t h e Enforcement Order  26  S e c t i o n 982 o f t h e U.S. IRC  162 27  Paragraph 66-5(7) of the STML: When i t i s necessary i n c o n n e c t i o n w i t h an a u d i t concerning the transactions between a c o r p o r a t i o n and a foreign a f f i l i a t e d person of s a i d corporation, officials of the National Tax A d m i n i s t r a t i o n or o f f i c i a l s of the d i s t r i c t taxation office and regional taxation bureau having jurisdiction over the p l a c e o f t a x payment of a c o r p o r a t i o n s h a l l be a b l e t o r e q u e s t of s a i d c o r p o r a t i o n the disclosure o r p r o d u c t i o n o f r e c o r d s or books, or c o p i e s t h e r e o f , over which s a i d f o r e i g n a f f i l i a t e d person m a i n t a i n s custody. In this case, i f s a i d c o r p o r a t i o n i s r e q u e s t e d t o d i s c l o s e or produce hereunder, i t s h a l l endeavor t o o b t a i n s a i d records and books, o r c o p i e s t h e r e o f .  28  A r t i c l e 153 o f the JCTL  29  Paragraph  30  The s p e c i f i c items t o be p r o v i d e d are as f o l l o w s ( A r t i c l e 2210 of S p e c i a l T a x a t i o n Measures Law Enforcement R e g u l a t i o n ) : (a) t h e reasons f o r which the f o r e i g n c o r p o r a t i o n corresponds to a foreign affiliated person p e r t a i n i n g t o the taxpayer corporation; (b) the amount o f c a p i t a l of the f o r e i g n a f f i l i a t e d person as of the end of the b u s i n e s s y e a r of s a i d taxpayer c o r p o r a t i o n and the c o n t e n t s of the p r i c i p a l business activities conducted by s a i d f o r e i g n a f f i l i a t e d person; (c) the t o t a l amount of c o n s i d e r a t i o n which t h e taxpayer corporation received, by type o f t r a n s a c t i o n , from i t s foreign affiliated c o r p o r a t i o n or the t o t a l amount of c o n s i d e r a t i o n which the taxpayer c o r p o r a t i o n p a i d , by type of transaction, t o i t s f o r e i g n a f f i l i a t e d person d u r i n g s a i d business year; (d) o t h e r matters r e q u i r e d f o r r e f e r e n c e .  31  For example, i n the case o f the Japan-U.S. Income Tax Convention, c o r r e s p o n d i n g adjustments have been made based on Paragraph 25(2) of the Convention.  32  Supra. note 5, a t 44  33  Supra, note 5, a t 44  34  Paragraph  35  Subparagraph 2 3 ( 2 ) ( i i i ) of the General Law of N a t i o n a l Taxes, Paragraph 6(4) of the Cabinet Order Implementing General Law of N a t i o n a l Taxes and A r t i c l e 7 of the Law f o r Enforcement of Tax T r e a t i e s  36  Supra. note 5, a t 45  37  Supra. note 3, a t p a r a . 18  66-5(7) of the STML  7(2) o f the Law  f o r Enforcement  o f Tax  Treaties  163  38  Supra. note 3, a t p a r a . 19  39  Supra, note 3, a t p a r a . 20  40  Supra. note 3, at para. 21  41  Supra, note 3, at p a r a . 22  42  Supra. note 3, at para. 22  43  Supra. note 3, at p a r a . 22  44  A "genuine" comparable u n c o n t r o l l e d p r i c e i s , f o r the amount of c o n s i d e r a t i o n of the good, which i s the t h a t i n v o l v e d i n the f o r e i g n a f f i l i a t e d t r a n s a c t i o n , the arm's l e n g t h t r a n s a c t i o n between the t a x p a y e r i n and an u n r e l a t e d p a r t y under the same c i r c u m s t a n c e s .  45  A " s o - c a l l e d " comparable u n c o n t r o l l e d p r i c e i s , f o r example, the amount of c o n s i d e r a t i o n of the good, which i s s i m i l a r t o t h a t i n v o l v e d i n the f o r e i g n a f f i l i a t e d t r a n s a c t i o n , sold in the arm's l e n g t h t r a n s a c t i o n between u n r e l a t e d p a r t i e s under the different circumstances. Accordingly, the d i f f e r e n c e s should be a d j u s t a b l e on some reasonable b a s i s f o r such a p r i c e t o be used as a comparable u n c o n t r o l l e d p r i c e .  46  Supra. note 3, a t p a r a .  24  47  Supra. note 3, a t p a r a .  28  48  Supra. note 3, a t p a r a .  28  49  T r a n s f e r P r i c i n g and M u l t i n a t i o n a l E n t e r p r i s e s . Report of the OECD Committee on F i s c a l A f f a i r s (1979), a t p a r a . 15 and 37  50  Supra. note 3, a t p a r a .  29  51  Supra. note 3, a t p a r a .  30  52  A r t i c l e 66-5 o f the STML and A r t i c l e 39-12 of the Enforcement Order o f t e n use the "foreign a f f i l i a t e d person", however, this f o r e i g n a f f i l i a t e d "person" means a f o r e i g n a f f i l i a t e d " c o r p o r a t i o n " . (Paragraph 66-5(1) of the STML)  53  S i n c e s u b s e c t i o n 69(1) of the Income Tax Act applies to a domestic t r a n s a c t i o n , the amount o f c o n s i d e r a t i o n i n such a domestic non-arm's l e n g t h t r a n s a c t i o n s h a l l be deemed t o be the f a i r market v a l u e . However, as stated i n page 14, Revenue Canada uses the same theory and p r i n c i p l e of t r a n s f e r p r i c i n g t o determine the f a i r market v a l u e as s u b s e c t i o n s (2) and (3) .  example, same as sold in question  164 54  The Japanese C o r p o r a t i o n Tax Law has t h e a n t i - a v o i d a n c e provision aimed a t t r a n s f e r p r i c i n g m a n i p u l a t i o n by a " f a m i l y c o r p o r a t i o n " . ( A r t i c l e 132 o f the CTL) However, the application of t h i s provision i s considerably r e s t r i c t e d , a l o n g w i t h t a x a u t h o r i t y ' s burden o f p r o o f , t h i s p r o v i s i o n i s useless at administrative l e v e l s .  55  Subparagraph 3 9 - 1 2 ( 1 ) ( i i i ) o f the Enforcement Order  56  A r t i c l e 84 o f the C o n s t i t u t i o n o f Japan p r o v i d e s : No new taxes s h a l l be imposed o r e x i s t i n g ones m o d i f i e d except by law o r under such c o n d i t i o n s as law may p r e s c r i b e .  165  CHAPTER IV CONCLUSION  1.  INTRODUCTION  As  discussed  international  i n the preceding  transfer  enforcement p r e s e n t  pricing  Although,  of  system  and i t s  to  both t a x  generally  been  most o f  successfully  o f t h e cases were s e t t l e d a t t h e s a c r i f i c e o f t h e  MNCs which c o u l d not but coffers  present  i n a c t u a l enforcement,  s e r i o u s double t a x a t i o n cases have some  taxation  the  a number o f d i f f i c u l t problems  a u t h o r i t i e s and MNCs.  avoided,  chapters,  countries  accept  whose  t h e double  system  and  taxation  or the  administration  have  deficiencies. However, the  present  Since  i t might not be p o s s i b l e o r a p p r o p r i a t e transfer  the present  countries,  p r i c i n g taxation l e g i s l a t i o n  legislation,  at  least  maintain  f u t u r e p o s s i b l e and  t h e balance  further drastic  practical  this  chapter  I  will  may not be  o f those i n t e r e s t s . improvements  would  e f f o r t s a t the l e v e l s of the tax administrators In  developed  i s f a i r l y reasonable f o r t h e purpose o f p r o t e c t i n g t h e  changes, even i f t e c h n i c a l l y o r p o l i t i c a l l y p o s s i b l e , to  change  drastically.  f o r the  i n t e r e s t s o f both t a x a u t h o r i t i e s and t a x p a y e r s ,  able  to  Therefore,  depend  upon  and t a x p a y e r s .  d i s c u s s p o s s i b l e improvements i n  166  i n t e r n a t i o n a l t r a n s f e r p r i c i n g t a x a t i o n system and key c o n s i d e r a t i o n s t o be g i v e n ,  based on mainly  the present  situations  of  Canada and Japan, and w i t h r e f e r e n c e t o two OECD r e p o r t s .  2.  POSSIBLE IMPROVEMENTS  More d e t a i l e d g u i d e l i n e o f t h e arm's l e n g t h p r i n c i p l e As mentioned i n Chapter Act  provides  only  II,  t h e p r e s e n t Canadian Income Tax  a general r u l e of t r a n s f e r p r i c i n g taxation.  U n t i l IC 87-2 was i s s u e d ,  taxpayers and t a x p r a c t i t i o n e r s  have  been  trying  t o deduce t h e i n t e r n a l g u i d e l i n e s o f Revenue Canada  from  actual  cases  information  and  circular  relatively  simple  Regulation.  other  explains  manner  information.  long-awaited  t h e arm's l e n g t h p r i n c i p l e i n a  i n comparison  I f t h e Canadian  The  taxpayer  with  t h e U.S.  can use  IRC  any method t o  c a l c u l a t e t h e reasonable arm's l e n g t h p r i c e and burden  of  is  might  be  t h e burden  of  laid  on  appropriate. proof  to  Revenue However,  use  the present  any  pricing  approach  under t h e Income Tax A c t ,  e s t a b l i s h t h e reasonableness  l a i d on t h e t a x p a y e r s , to  Canada,  of the t r a n s f e r p r i c e s i s  although t h e taxpayer method,  r e a s o n a b l e arm's l e n g t h p r i c e .  providing  i s legally  the t r a n s f e r p r i c e s w i t h c e r t a i n t y .  entitled  that i t r e s u l t s i n the  Since there i s l i t t l e  dence i n t h i s area, i t i s v e r y d i f f i c u l t  proof  jurispru-  f o r t h e taxpayers t o f i x  On t h e c o n t r a r y , a t present,  d e s p i t e t h e d e f i c i e n c y , f i e l d a u d i t o f f i c a l s o f Revenue Canada do not seem t o f e e l much inconvenience  and d i f f i c u l t y .  167 However, particular  once  Revenue  methods  Canada  i n IC 87-2,  g u i d e l i n e s on the use of the  recommends  the  use  i t should p r o v i d e more d e t a i l e d  pricing  method,  even  though  d e t e r m i n a t i o n of the arm's l e n g t h p r i c e i s a q u e s t i o n of f a c t it  would  be  of  the and  d i f f i c u l t t o p r o v i d e g e n e r a l g u i d e l i n e s which meet  every case such as  in  determining  capital  gains  or  business  I t seems t o be a p p r o p r i a t e and p o s s i b l e t o p r o v i d e  detailed  incomes.  explanation, U.S.  through  IRC R e g u l a t i o n .  the p r e s e n t IRC guidelines  use of a number of examples as i n the  Although U.S.  Regulation  by  unnecessary  the  Revenue  is  taxpayers a l s o complain  not  detailed  Canada  using  arguments and augment t a x  enough,  examples  may  pricing  g u i d e l i n e s f o r the p h a r m a c e u t i c a l  i s p r e p a r i n g t o do the same f o r o t h e r  On the o t h e r hand,  detailed reduce  compliance.  I t s h o u l d be noted t h a t Revenue Canada has a l r e a d y specific  that  industries.  under the new  Japanese  set  out  i n d u s t r y and  1  system,  fairly  c o n c r e t e c a l c u l a t i o n methods of an arm's l e n g t h p r i c e are w r i t t e n in  the  law  and d e t a i l e d i n t e r p r e t a t i n g r u l e s a r e s t a t e d i n the  Enforcement Order.  Further d e t a i l s  provided  necessary  NTA  whenever  of  interpretation  will  be  i n t h e form of a " D i r e c t i v e of the  Commissioner".  "Advance R u l i n g " and " C o n f i r m a t i o n System" Since  1970,  Revenue  Canada  has  been  r u l i n g s " which enable the taxpayer t o know what  p r o v i d i n g "advance t a x consequences  168 would  arise  from  a  business  transaction  which  the  taxpayer  2  proposes  to  c a r r y out.  The advance r u l i n g i s an a d m i n i s t r a t i v e 3  procedure  and  procedures 70-6R.  there  to  be  is  no  legislative  for  taken are s e t out i n the I n f o r m a t i o n  it.  The  Circular  The o b j e c t i v e s are t o p r o v i d e c e r t a i n t y i n r e s p e c t of the  proposed  business  compliance  transactions 4  accepted  and  if  there  application  for  is 5  fide  proposed t r a n s a c t i o n .  a  bona  Therefore,  promote  voluntary  application.  6  Although,  the  advance  rulings  business  is  only  purpose f o r the  i f the t a x p l a n n i n g motive  dominant i n the proposed t r a n s a c t i o n ,  advance  to  and u n i f o r m i t y .  The taxpayer's  the  basis  Revenue Canada w i l l  number  of  is  refuse  applications  and  r u l i n g s i s s u e d i s s i g n i f i c a n t and r e q u i r e s the work of a  number o f r u l i n g  officers,  according  to  Revenue  Canada,  tax  p r a c t i t i o n e r s complain t h a t rulings are o n l y o b t a i n a b l e i n the clearest of circumstances i n accordance with an overly strict interpretation o f the law, and that there is a r e l u c t a n c e t o grant r u l i n g s i n c o n t e n t i o u s a r e a s . It i s a l s o r e c o g n i z e d t h a t the procedure i s time-consuming and t h e r e are d e l a y s in processing the ruling application. 7 Although  the  determination  of  t r a n s f e r p r i c i n g case i s a q u e s t i o n of s u i t a b l e f o r advance r u l i n g s , to  be a u s e f u l way  guideline  an arm's l e n g t h p r i c e i n a fact  and  might  not  the advance r u l i n g procedure  t o make up f o r the d e f i c i e n c y i n  of the t r a n s f e r p r i c i n g t a x a t i o n system.  the  it  seems  present  In a d d i t i o n ,  even though the d e t e r m i n a t i o n o f the arm's l e n g t h p r i c e i s oriented,  be  case-  i s expected t h a t the p u b l i c a t i o n o f a c t u a l r u l i n g s  169  concerning guidelines  transfer  pricing  cases  would  Revenue Canada seems  not t o  A c c o r d i n g t o Revenue Canada's e x p e r i e n c e , applications  are  do not always  make  the intra-group  transaction  f o r a requested r u l i n g .  f a i l t o provide a l l the relevant rulings  f o r no apparent reason,  voluminous g As  to  documentation  implication  documentation,  i n the past.  or request  specifically  of rulings,  many facts  identifying  Revenue Canada has  But t h e r u l i n g  on  the tax  o f a p a r t i c u l a r case tends t o become o b s o l e t e due t o  changes i n t h e t a x law o r i t s i n t e r p r e t a t i o n , to r e v i s e the f a c t s contained i n a r u l i n g Therefore  They may  o r they may bury m a t e r i a l  without  the publication  published rulings  d e l i b e r a t e l y o r not,  t h e r e a l purpose o f t h e t r a n s a c -  and t h e reason and b a s i s  them.  optimistic.  MNCs which make r u l i n g  the tax p r a c t i t i o n e r s often,  f a i l t o d i s c l o s e a l l the facts,  in  so  o r n o t used i n a proper manner by t a x p r a c t i t i o n e r s .  example,  tion,  be  f o r bona f i d e b u s i n e s s purposes and t h e r u l i n g procedures  abused,  For  convenient  f o r taxpayers.  However,  solely  present  Revenue  Canada  decided  to  not t o  and i t i s d i f f i c u l t t h e changed undertake  law.  further  9  publication by  of the r u l i n g s .  the tax p r a c t i t i o n e r  Although t h e above-mentioned abuses might  b e s i d e s Revenue Canada's t r o u b l e , the  r u l i n g be i s s u e d  where  be exaggerated t o some extent, MNCs might n o t be a b l e t o wait  t h e proposed t r a n s a c t i o n  required to  be u r g e n t l y made. C o n s i d e r i n g t h e above-mentioned p r e s e n t s i t u a t i o n o f advance ruling the  procedure,  ruling.  one  However,  should n o t o v e r - e s t i m a t e t h e f u n c t i o n o f  as l o n g as Revenue Canada's g u i d e l i n e s f o r  170 the arm's l e n g t h p r i n c i p l e remains rulings  will  be  at  present  levels,  advance  one of few measures a v a i l a b l e t o a l l e v i a t e the  u n c e r t a i n t y of i t s a p p l i c a t i o n .  In Japan, the NTA equivalent  to  Commissioner's S p e c i f i c D i r e c t i v e might be  Revenue  Canada's  D i r e c t i v e i s NTA's o f f i c i a l p a r t i c u l a r case.  cases.  interpretation  assessment  However,  human r e s o u r c e s . Law,  ruling. of  A  tax  there  by are  NTA  officials  v e r y time-consuming.  in  in  other  can  number  published.  D i r e c t i v e s i s s u e d per  annum  Thus,  is  very  Canada's advance r u l i n g s .  head  an o r d i n a r y case r e q u i r e s the Specific  and  Tax  I t i s also  a p p r o v a l from a t l e a s t 10 o f f i c i a l s b e f o r e a  Revenue  binds  the  as p a r t of t h e i r work.  For example,  a  and  For example, i n the case o f the C o r p o r a t i o n  o f f i c e d e a l w i t h the procedure  issued  in  c o n s t r a i n t s due t o l i m i t e d  o n l y some 30 o f f i c i a l s i n the r u l i n g s e c t i o n  be  Specific  laws  A c c o r d i n g l y , i t becomes the precedent  the i n t e r p r e t a t i o n and similar  advance  the few  in  Directive of S p e c i f i c  comparison  In a d d i t i o n ,  with  the taxpayer i n  Japan who  makes an a p p l i c a t i o n f o r a S p e c i f i c D i r e c t i v e would  required  t o p r o v i d e the d e t a i l e d i n f o r m a t i o n of the t r a n s a c t i o n .  Therefore, limited  the i s s u a n c e o f the D i r e c t i v e s i n f a c t  to  the  significant.  officials Counselors  cases",  In most cases,  interpretation transaction,  "big  of  tax  where  the  tax  to  be  consequence are  where taxpayers want  to  know  the  laws or t a x consequences of a p a r t i c u l a r  taxpayers use the Tax Counselors informally.  tends  be  Opinions  thus  or ask  provided  by  other  tax  the  Tax  or o t h e r t a x o f f i c i a l s have no b i n d i n g e f f e c t s .  171 S i n c e Japanese tax p r a c t i t i o n e r s have not  been  aggressive  i n a r g u i n g the i n t e r p r e t a t i o n of tax laws w i t h the t a x a u t h o r i t y , there  have  so f a r been few complaints  situation. transfer  However,  taxpayer  as s t a t e d i n Chapter I I I ,  p r i c i n g t a x a t i o n system,  the " c o n f i r m a t i o n would  system".  the NTA  Under  the  propose t o the NTA  of  the  essential  A f t e r undertaking finds  under  1 0  i s going t o  confirmation  most  information  system,  the NTA  if  of  NTA,  the  and  the the  the  NTA  w i l l g i v e the taxpayer  T h i s should cause a c o n s i d e r a b l e  to  and  a  he i s w i l l i n g t o p r o v i d e .  s o r t of c o n f i r m a t i o n . workload  new  introduce  reasonable  in-depth s t u d i e s o f the p r o p o s a l ,  the p r o p o s a l reasonable,  the  the method o f determining  arm's l e n g t h p r i c e which he t h i n k s i s scope  about the above-mentioned  increase  s i m i l a r problems experienced  Revenue Canada and Canadian tax p r a c t i t i o n e r s might be  a  by  expected.  However, the o b j e c t i v e s of the c o n f i r m a t i o n system, t h a t i s , to  prevent  the occurrence  to eliminate  possible  international e f f e c t i v e and  of t r a n s f e r p r i c i n g t a x a t i o n cases  uncertainties  as  much  as  t r a n s a c t i o n s are q u i t e a p p r o p r i a t e , e f f i c i e n t enforcement must be  possible  and in  therefore i t s  found.  S a f e Haven As  stated  i n Chapter I I ,  1 1  r u l e s w i l l reduce the u n c e r t a i n t y arguments  i t i s expected t h a t s a f e haven of  taxpayer  and  unnecessary  between the tax a u t h o r i t i e s and t a x p a y e r s .  a number o f problems, application.  But  i t has  such as an a r b i t r a r i n e s s or complexity  Furthermore  where  i n s e t t i n g out c e r t a i n s a f e haven  in  one tax a u t h o r i t y c o u l d succeed ranges,  unless  the  relevant  172 foreign  t a x a u t h o r i t y a c c e p t s such r u l e s ,  would make an i n t e r n a t i o n a l i n t r a - g r o u p o f double t a x a t i o n  would s t i l l  f o r the taxpayers  transaction,  remain.  the danger  An agreement on the  haven range i n a p a r t i c u l a r i n d u s t r y between the tax would  usually  need  the v e r y  least,  to  out  set  particular  safe  taxpayer about  will  that  haven  or the  the  increase  The  authorities  a j o i n t i n d u s t r y study as p r e r e q u i s i t e .  range  industry taxpayer  area  for  the  should or  f o r e i g n t a x a u t h o r i t i e s i n advance. likely  safe  At  t h i s means t h a t the tax a u t h o r i t y which i s going  the  information  who  t r a n s a c t i o n by a provide  detailed  to  relevant  industry Therefore  the  i t does  not  seem  i n which s a f e haven r u l e s can be s e t  out  f o r the near f u t u r e .  NTA's  confirmation  system  also  from  double  aims t o s e t out  safe  haven r u l e s . To p r o t e c t r e a l i z e s that treaty  the  taxpayer  taxation,  i t i s d e s i r a b l e t o secure i n advance  partners'  the  the  NTA  relevant  i n f o r m a l concurrence or t a c i t u n d e r s t a n d i n g of 12  the p r o p o s a l . to  get  As s t a t e d i n Chapter I I I  even  authorities,  the NTA  concurrence  since i t i s d i f f i c u l t from  the  i t would not be p r a c t i c a l f o r the NTA  acceptance. procedures  informal  ,  Although of  would be  the  the  nature  confirmation  or  effect  foreign t o seek and  specific  i n a d i f f i c u l t s i t u a t i o n t h a t i f the f o r e i g n tax  transaction  the c o n f i r m a t i o n  formal  system are under c o n s i d e r a t i o n ,  a u t h o r i t y makes adjustments on the t r a n s f e r p r i c e s i n intra-group  tax  to  which  the  NTA  had  taxpayer's  already  given  as the reasonable p r i c i n g method t o c a l c u l a t e an  173 arm's l e n g t h p r i c e ,  and the NTA  fail  the  to  agree  on  agreement procedure. tax a u t h o r i t y  the f o r e i g n  corresponding  Even i f the adjustment made by  t o make  relief  a corresponding  i s o b l i g e d t o make  adjustment  sort  p o l i c y on t h i s matter. the  number  of  the taxpayer would  t o a l l e v i a t e double t a x a t i o n .  other  of  such  or  a  corresponding  r e l i e f would depend on the NTA's  I f the NTA  accepts  such  an  obligation,  a p p l i c a t i o n s would i n c r e a s e and the NTA revenue  this  should  viewpoint,  deliberate  d e c i d i n g t h e procedure  provide  In such a case  r e l u c t a n t t o g i v e a c o n f i r m a t i o n t o prevent  w  authority  the f o r e i g n  adjustment  whether o r not the NTA or  tax  adjustment i n t h e mutual  i s not a c c e p t a b l e f o r the NTA,  request the NTA unilateral  and  consideration  might be  loss. be  From  given i n  and e f f e c t o f the system.  Transaction-bv-transaction  H  approach 13  As s t a t e d i n Chapter I I  ,  Revenue Canada's t r a n s a c t i o n - b y -  t r a n s a c t i o n approach has been s e v e r e l y  criticized  by  taxpayers  and t a x p r a c t i t i o n e r s a r g u i n g t h a t : (i)  there i s  Income Tax (ii) group  no l e g a l a u t h o r i t y f o r such an approach under the  Act,  i n the case o f a "package d e a l " transactions  of  MNCs,  it  which  i s common i n i n t r a -  i s o f t e n v e r y complicated  sometimes i m p o s s i b l e t o i d e n t i f y the v a r i o u s items i n a  deal  and as  s e p a r a t e t r a n s f e r s and t o e v a l u a t e and charge s e p a r a t e l y , and ( i i i ) what may  seem unreasonable  t r a n s a c t i o n b a s i s may maximization  when viewed on a t r a n s a c t i o n - b y -  be q u i t e reasonable  i n r e l a t i o n to overall 14 of the p r o f i t s of the taxpayer. To conform t o the  174 arm's l e n g t h p r i n c i p l e , Revenue Canada should taken by t h e I R S  and t h e OECD R e p o r t .  1 5  On t h e other present  hand,  Revenue  f o l l o w t h e approach  1 6  Canada  understands  that  t r a n s f e r p r i c i n g taxation l e g i s l a t i o n provided  69 o f t h e Income Tax Act, u n l i k e t h e U.S. does not p r o v i d e taxpayers  and  i n section  I n t e r n a l Revenue Code,  f o r t h e r e a l l o c a t i o n o f income between non-residents.  Accordingly  resident  s e c t i o n 69 a p p l i e s t o  each t r a n s a c t i o n between t h e v a r i o u s r e l a t e d p a r t i e s and the Canadian t a x a b l e  the  not t o  income, r e t u r n on s a l e , r e t u r n on e q u i t y , o r 17  other measurements o f g e n e r a l  profitability.  Canada c o u l d not accept t h e s o - c a l l e d  Therefore,  "bottom  line"  Revenue  approach, 18  which enables a taxpayer t o a v o i d t h e adjustment i n most While  i t might  valuation facilitate  of  be  true  various  that  products  a  separate  and  i d e n t i f i c a t i o n and  services  will  not  only  t h e a u d i t o f i n t e r n a t i o n a l t r a n s a c t i o n s but w i l l 19  a s s i s t t h e i r n e g o t i a t i o n s t o a v o i d double t a x a t i o n , application of a transaction-by-transaction an  cases.  intolerable  the  also  strict  approach would impose  burden on MNCs and would d i s t o r t t h e f l e x i b i l i t y  o f sound economic a c t i v i t i e s by MNCs. However, i t seems t h a t Revenue Canada w i l l not always i n t e n d to  apply  the transaction-by-transaction  approach.  t h a t i t w i l l a n a l y z e intra-company r e l a t i o n s h i p s  Its policy i s on  a  transac-  20  tion-by-transaction  basis  whenever  possible,  but i f not,  i t  w i l l a n a l y z e t h e p r i c i n g o f a p a r t i c u l a r product d u r i n g t h e year, or focus on a p a r t i c u l a r product l i n e and so on. IC 87-2 s t a t e s : I f t h e above [ i . e . t r a n s a c t i o n - b y - t r a n s a c t i o n ] approach i s not p r a c t i c a l o r proves u n r e a l i s t i c i n terms o f t h e  175 manner i n which the p a r t i c u l a r i n d u s t r y conducts i t s business, then the taxpayer should be prepared t o provide, i n a comprehensive statement o f intercompany p r i c i n g p o l i c y , the b a s i s on which t r a n s f e r p r i c e s are e s t a b l i s h e d world-wide. 21 Therefore, between  in  Revenue  practice,  Canada  discrepancies  and  in  approach  the taxpayers might not be  so  serious.  As  stated e a r l i e r ,  pricing  taxation  Taxation  Measures Law,  Income  Tax  legislation,  Act,  Revenue Code.  the p r o v i s i o n s of the Japanese paragraph 66-5(1) of the  i s s i m i l a r t o s e c t i o n 69 of the  rather  than s e c t i o n 482  Accordingly,  to  the NTA  has  not  deals,  set-off  various  items  impossible.  revealed  its  as  in  a  transaction  approach  However,  one  might  should  possible  the  effects  not  to neutralize  which  voluntary  compliance o f taxpayers,  an  burdens  arm's  transaction-by-transaction  reasonable  that i s ,  reasonable  administrative  be the  f a i r and  of  package  consider  activities,  evaluation  regarding  NTA's  on  length basis,  and  and  helps  the  secure  ensure  should NTA's  Although be  or  as on a  long-term  t o minimize e x c e s s i v e  taxpayers. price  to  of  basic  of t r a n s f e r p r i c i n g t a x a t i o n  assessment  be  At t h i s p o i n t i n time,  l e g i t i m a t e economic d e c i s i o n s and  costly  Internal  or other s i t u a t i o n s where s e p a r a t e e v a l u a t i o n  p r i n c i p l e s mentioned i n Chapter I I I , much  Canadian  Canadian t a x p a y e r s might  the Japanese l e g i s l a t i o n . yet  o f the U.S.  Special  the same k i n d o f arguments which have  been made between Revenue Canada and applicable  transfer  made  attitude  and the  on can  a be  176 expected  more  flexible  and  generous  f o r the  "bottom  line"  approach.  Cross-check and r e a s o n a b l e allowance o f t h e arm's l e n g t h As  t h e OECD Report recommends,  i t i s q u i t e reasonable and  d e s i r a b l e t h a t t h e t a x a u t h o r i t i e s should v e r i f y t h e ness  price  reasonable-  o f t h e p r o v i s i o n a l l y a c c e p t a b l e p r i c e s which a r e c a l c u l a t e d  as t h e arm's l e n g t h  prices  based  on  a  particular  another p r i c i n g method which i s a l s o a v a i l a b l e ,  method  by  even though l e s s  22 r e a s o n a b l e t o apply. reasonable example  arm's  where  available,  I n o t h e r words,  length  price  t h e genuine  i t may  except t h e case  comparable  uncontrolled  and  computations t o c r o s s - c h e c k t h e arm's l e n g t h  by  so-called  useful  a  can be c l e a r l y i d e n t i f i e d , f o r  be necessary t o make a d d i t i o n a l  "other  where  methods".  Although  price  is  calculations  price  derived,  those methods a r e not  i n f i n d i n g an arm's l e n g t h p r i c e i n i s o l a t i o n , they can be  v e r y u s e f u l as measures t o v e r i f y t h e p r i c e d e r i v e d  by one o f t h e  23 t h r e e b a s i c methods. This administrative  p r a c t i c e should f a c i l i t a t e t h e f a i r  reasonable  enforcement  and  t h e taxpayers a g a i n s t  protect  Furthermore, would  indicate  length p r i c e .  of  the t r a n s f e r p r i c i n g taxation  cross-checks a  reasonable  As t h e OECD  cases, the transactions comparable with  system  unnecessary adjustments. using  range  Report  within those  and  various or  states,  pricing  methods  allowance o f t h e arm's i n most  of  actual  MNEs may n o t be d i r e c t l y which take p l a c e between  177 independent e n t e r p r i s e s so t h a t allowances have t o be made i n comparing t h e i r t r a n s f e r p r i c e s w i t h t h e p r i c e s payable between independent e n t e r p r i s e s . 24 Where  d i f f e r e n c e s e x i s t between t h e t r a n s f e r p r i c e and a compar-  able p r i c e ,  such d i f f e r e n c e should be q u a n t i f i e d  and  adjusted.  However, u n q u a n t i f i a b l e o r u n a d j u s t a b l e d i f f e r e n c e s might remain, and  t h e r e f o r e a reasonable allowance should Revenue  t h i s issue  Canada  not  c l e a r l y expressed i t s a t t i t u d e on  y e t . But, c o n t r a r y  expectations, calculating seems  has  be granted.  to  a  few  Revenue Canada has been making t h e arm's l e n g t h  price  cynical  taxpayers'  genuine e f f o r t s i n  prudently.  Revenue  Canada  t o understand t h a t a reasonable arm's l e n g t h p r i c e may not  be an a s c e r t a i n a b l e amount, tion.  After  but r a t h e r a  reasonable  approxima-  t h e c a l c u l a t i n g t h e p r o v i s i o n a l arm's l e n g t h p r i c e ,  i t s f i e l d a u d i t o r s u s u a l l y c r o s s - c h e c k t h e r e s u l t o f t h e i r comput a t i o n s w i t h o t h e r p r i c i n g methods  or  make  a n a l y s i s , o r re-examine t h e c o m p a r a b i l i t y a c t i o n they  further  functional  of the unrelated  trans-  referenced. 25  As s t a t e d i n Chapter I I I , n e c e s s i t y and u s e f u l n e s s methods  and  length p r i c e . operating  of  t h e NTA a l s o f u l l y  cross-checking  with  r e a l i z e s the  other  pricing  t h e g r a n t i n g o f a reasonable allowance t o t h e arm's The NTA p l a n s  to  adopt  such  considerations  as  g u i d e l i n e s when e n f o r c i n g t h e t r a n s f e r p r i c i n g t a x a t i o n  system. Mutual c o o p e r a t i o n  between t a x a u t h o r i t i e s  The OECD 1984 Report recommends  that  the tax authorities  178 augment  mutual  cooperation  with  c o u n t r i e s through the exchange  t h e i r counterparts i n foreign  of  information  and  communicate  w i t h each o t h e r i n t r a n s f e r p r i c i n g matters in as flexible a manner as p o s s i b l e , whether i n writing, by telephone, by f a c e t o f a c e o r round the t a b l e d i s c u s s i o n , whichever i s most s u i t a b l e . 26 In  this  context,  it  can  between Revenue Canada and the IRS  be  said  t h a t the  relationship  e x e m p l i f i e s the OECD recommen-  dations. In the area of i n f o r m a t i o n exchange, have engaged s u c c e s s f u l l y i n "automatic" of Tax  both and  tax  authorities  " s p e c i f i c " exchanges  i n f o r m a t i o n based on A r t i c l e XXVII of the Canada-U.S. Convention.  27  In  addition,  Income  they have s t a r t e d s i n c e 1977  a  28  simultaneous  examination  ( c i v i l ) program.  the taxpayers which are u s u a l l y l a r g e both  countries  Under  MNCs  this  with  program,  operations  and use t a x havens as a p a r t o f t h e i r  in  activities  29  have been s e l e c t e d .  Owing t o v a r i o u s f a c t o r s such as the  volume of world-wide s a l e s and a s s e t s and e x i s t e n c e of tax y e a r s f o r both c o u n t r i e s , which should be taken 30 . . i n s e l e c t i n g the case, of a c t u a l examination  and  program i s not o n l y u s e f u l f o r e f f e c t i v e but  also  provides  benefits  encouraging  the  sharing  consistent  adjustments  of in  to  limited. and  taxpayers.  fresh both  the number  However,  economical For  information countries,  identical  i n t o account  l i m i t e d human r e s o u r c e s ,  per annum i s s t i l l  dollar  this audits  example, and  by  ensuring  possible  double  31 t a x a t i o n s i t u a t i o n s can be avoided provide information,  and  taxpayers'  e s p e c i a l l y foreign-based  burden  to  i n f o r m a t i o n t o the  179 tax  authorities  are  minimized.  In  connection  with  the  simultaneous examination program, Revenue Canada and t h e IRS have commenced  a  "joint  industry  studies"  o b j e c t i v e s o f t h e program a r e t o o b t a i n world-wide  industry  program.  The  comprehensive  main  data  on  practices  and o p e r a t i n g p a t t e r n o f v a r i o u s  ( Revenue  Canada  32 major  industries.  arrangements products,  with  has  industry  several countries a t present,  grain,  studies  and t h e f o r e s t  o i l and drug i n d u s t r i e s have been  studied  in  33 those  programs.)  Information obtained  i n those s t u d i e s would  h e l p more e f f e c t i v e review o f t a x r e t u r n s o f MNCs by industry's  usage  of  t a x havens  c a n d i d a t e s f o r simultaneous Furthermore,  and  selection 34  of  potential  examination.  t h e "spontaneous"  exchange o f i n f o r m a t i o n has  a l s o developed between both two a u t h o r i t i e s and  identifying  both  quantitatively  qualitatively. In t h e area  Canada  and  each o t h e r .  of  t h e mutual  t h e IRS  agreement  procedure,  Revenue  have been s u c c e s s f u l i n communicating w i t h  A t p r e s e n t , they conduct f a c e - t o - f a c e meetings  quarterly basis,  and they always d e a l c o n s t a n t l y w i t h 35  on a  more than  50 cases p e r annum.  MNCs have been concerned about "broad brush"  or  approach  "package  deal"  between t a x a u t h o r i t i e s ,  mutual agreement procedures a r e s e t t l e d , each i n d i v i d u a l case,  n o t on  that i s ,  the merits  of  b u t on t h e b a s i s o f a b a l a n c e o f i n t e r e s t  between t h e competent a u t h o r i t i e s themselves.  As t h e OECD 1984  Report states, mutual agreement procedure cases "should each be any b a l a n c e o f t h e r e s u l t s i n o t h e r c a s e s . " However, i t can be s e t t l e d on t h e i r own i n d i v i d u a l m e r i t s and not by 36  reference to  180 s a i d t h a t the e x i s t e n c e of  a  number  of  other  cases  and  the  importance of keeping good r e l a t i o n s sometimes make the competent authorities  reach  would reduce  an  agreement  the revenue  "emotionally"  to  reluctant  in  a case where the agreement  i t s coffers  to  accept  and  for  the  A c t u a l l y most of the double t a x a t i o n cases which  be  accordingly,  tax  authority.  were  discussed  i n mutual agreement procedures have been s e t t l e d .  On the o t h e r hand,  although  Japan has had t a x t r e a t i e s  with  v a r i o u s c o u n t r i e s and most of them had the p r o v i s i o n f o r exchange of  information,  the  i n f o r m a t i o n exchanges. did  the NTA  NTA  has  the  importance  thought they c o u l d implement any  or  e v a s i o n scheme due  IRS  possessed  t o the NTA's long-time  authorities.  of  such as the MNCs  inability  avoidance to obtain  i n f o r m a t i o n , were s u r p r i s e d t o r e c e i v e t e l e x e s from  investigated the  usefulness  i n t e r n a t i o n a l tax  t h e i r overseas branches or s u b s i d i a r i e s t h a t the  and  The Japanese taxpayers,  who  foreign-based  of  Only a f t e r becoming a member o f the PATA,  became r e a l i z e d  i n f o r m a t i o n exchanges.  not been making e f f e c t i v e use  their  information The  number  offices obtained  of  cases  f o r e i g n tax a u t h o r i t i e s t o the NTA  Revenue  and  that  from  the  of  Canada  NTA  officials  foreign  information provided  doubled from 1980  t o 1984  the number o f cases o f i n f o r m a t i o n p r o v i d e d by the NTA  or  tax by and  to foreign  tax a u t h o r i t i e s i n c r e a s e d t h r e e times f o r the same p e r i o d . The  NTA  has  been s u c c e s s f u l i n c u l t i v a t i n g the  s h i p s w i t h the PATA member c o u n t r i e s , i . e . Australia.  The NTA  has  Canada,  realation-  the U.S.  and  commenced semi-annual h i g h - l e v e l f a c e - t o -  181 face  meetings  with  the  IRS and a l s o concluded an agreement on  simultaneous examination w i t h t h e IRS i n 1985.  The NTA has  also 37  p a r t i c i p a t e d w i t h PATA members i n t h e i n d u s t r y - w i d e s t u d i e s . can  be s a i d t h a t due t o these r e l a t i o n s h i p s ,  It  the p o s s i b i l i t y of  u n r e l i e v a b l e double t a x a t i o n has been c o n s i d e r a b l y reduced. However, i t s h o u l d be r e c o g n i z e d t h a t t h e NTA's r e l a t i o n s h i p with i t s foreign counterparts i s s t i l l comparison IRS.  i n t h e stage o f i n f a n c y i n  w i t h t h e r e l a t i o n s h i p between Revenue Canada  and t h e  S i n c e c o o p e r a t i o n and mutual understanding w i t h f o r e i g n t a x  authorities enforcement  i s of  utmost importance  f o r the f a i r  and e f f e c t i v e  o f t h e new Japanese t r a n s f e r p r i c i n g t a x a t i o n  above a l l , t h e c o n f i r m a t i o n system,  system,  t h e NTA should s t r e n g t h e n i t s  r e l a t i o n s h i p w i t h n o t o n l y PATA members b u t a l s o w i t h  other  tax  a u t h o r i t i e s as soon as p o s s i b l e . C l o s e m o n i t o r i n g by headquarters There has been a complaint t h a t i n t h e U.S., due t o t h e l a c k of  a p p r o p r i a t e m o n i t o r i n g and s u p e r v i s i o n o f s e c t i o n 482 a l l o c a -  t i o n cases by t h e headquarter make unreasonable prices  of  MNCs.  district office  i n Washington, D.C., f i e l d a u d i t o r s  or inconsistent  adjustments  on  the  S i n c e i r r e v o c a b l e s t e p s have been taken a t t h e level,  such  adjustments  cause  prolonged  c o s t l y mutual agreement proceedings when s e t t l i n g c a s e s . be  said  transfer  and  I t can  t h a t t h e e a r l i e r t h e competent a u t h o r i t y c o n s i d e r a t i o n s  are taken, resolved. whenever a  t h e e a s i e r and f a s t e r double Therefore, field  i t might  auditor  plans  be to  taxation  reasonable make  a  case  can be  t o require that transfer  pricing  182 adjustment make  a  on  an i n t e r n a t i o n a l t r a n s a c t i o n by a MNC,  referral  to  adjustments  would  headquarters  should  t h e headquarter.  result  i n double  closely  monitor  In  cases  taxation the  he should where  such  f o r the  assessment,  MNC,  and i f  n e c e s s a r y take over a t an e a r l y stage.  38  As  stated  i n Chapter  III,  t h e NTA f u l l y r e a l i z e s t h e  n e c e s s i t y and importance o f c l o s e m o n i t o r i n g and i s p l a n n i n g t o establish office, strictly  the  Special  Staff  f o r International  Audits.  along with the O f f i c e of International' Operations, control  the  assessment  made by f i e l d a u d i t o r s  This will i n the  39  d i s t r i c t t a x a t i o n o f f i c e s and r e g i o n a l t a x a t i o n In Revenue Canada, office  i s i n charge  bureaus.  t h e i n d u s t r y s t u d i e s s e c t i o n i n t h e head of  the  enforcement  of transfer p r i c i n g  t a x a t i o n , and some s o r t s o f guidance and s u p e r v i s i o n  seem t o have  been adequately p r o v i d e d i n some areas by t h a t s e c t i o n auditors  in district  Although audits, transfer  such  to  field  offices. monitoring  may  be seen as uneconomical f o r  i t would secure r e a s o n a b l e and c o n s i s t e n t enforcement o f pricing  taxation  which  s h o u l d h e l p p r o t e c t MNCs from  double t a x a t i o n and reduce unnecessary mutual agreement procedure cases. S e l f d i s c i p l i n e and documentation by MNCs As a f i n a l p o s s i b l e improvement, that  a  MNC  should  length p r i n c i p l e .  make  every  i t should  be  emphasized  e f f o r t t o conform t o t h e arm's  183 In Canada,  as s t a t e d b e f o r e ,  under  t a x p a y e r s can adopt any p r i c i n g method. recommended t h a t Canadian taxpayers methods  provided  in  IC  87-2,  procedures  those  since  the p r i c i n g  b a s i c methods a r e  practical are  Tax A c t ,  i t i s strongly  follow  those  methods  important c r i t e r i a when r e a c h i n g  Income  However,  should  u s u a l l y not o n l y t h e e a s i e s t and most agreement  the  but  also  i n mutual  recognized  as  an agreement among t h e competent  authorities From t h e e x p e r i e n c e s i n t h e  U.S.,  however,  i n practice,  those b a s i c methods have o f t e n been proved i m p r a c t i c a l . be  proved  to  be  more  practical  to  base on a taxpayer's own  p r i c i n g method, s i n c e a taxpayer cannot always apply functional analysis or obtain mark-up  o f i t s competitors.  information  such  In such cases,  professional  as  the  possible  required, Revenue  with  regard  provide Canada.  t o the s i t u a t i o n ,  a l l the information Contrary  profit  i t i s also strongly  recommended t h a t a taxpayer r e c o r d h i s t r a n s a c t i o n s as as  I t might  precisely  and whenever he i s  o f which he has custody t o  t o the tax p r a c t i t i o n e r s ' expectation,  Revenue Canada i s n o t so m e r c i l e s s when c o l l e c t i n g money from t h e taxpayers. concerned  Rather, with  i t s f i e l d auditors are  small  percentage  not  to  be  d i f f e r e n c e s and t o accept the  t a x p a y e r ' s p r i c i n g arrangements as long as been  trained  the  arrangement  r e a s o n a b l y and c o n s i s t e n t l y operated i n comparable  w i t h independent p a r t i e s as w e l l as w i t h i n t h e  MNC  has  dealings  and  can  be  40  evidenced  by s u f f i c i e n t documents.  I t should  n e c e s s i t y and importance o f a p p r o p r i a t e  documentation 41  recognized  by t h e c h a r t e r e d  accountants.  be noted t h a t the are  also  184  In Japan, s i n c e f a i r l y c o n c r e t e p r i c i n g methods a r e p r o v i d e d in  the  "law" and  authorized,  cabinet  taxpayers  prescribed.  However,  a c t u a l l y applying of taxpayers  have  order,  words,  legally  a r e r e q u i r e d t o use t h e s p e c i f i c  methods  t h e NTA those  i n other  realizes  methods.  the d i f f i c u l t i e s  Accordingly,  no i n t e n t i o n o f a v o i d i n g o r evading  been c o o p e r a t i v e w i t h t h e NTA d u r i n g an a u d i t , not  have  t o worry  so  much  about  p r o v i d e a l l necessary  they  taxpayers  long  as  t a x and have usually  adjustments.  c o n s i d e r i n g t h e presumption p r o v i s i o n ,  3.  as  of  do  Furthermore,  a r e expected t o  i n f o r m a t i o n r e q u i r e d by t h e t a x o f f i c i a l s .  KEY CONSIDERATIONS TO BE GIVEN  Dishonest Most  MNC v s . honest MNC of  the transfer p r i c i n g taxation l e g i s l a t i o n applies  whether o r n o t t h e taxpayer  intends  to  avoid  or  evade t a x .  S i n c e , even MNCs themselves cannot always f i x t h e t r a n s f e r p r i c e s in  t h e i r i n t r a - g r o u p t r a n s a c t i o n s t o conform t o t h e arm's l e n g t h  p r i n c i p l e which a r e accepted  by t a x a u t h o r i t i e s , MNCs have always  complained t h a t t a x treatments a g a i n s t "honest" taxpayers arm's  such  t h e burden  The MNCs argue t h a t  should be t r e a t e d d i f f e r e n t l y from d i s h o n e s t  On t h e o t h e r administrators  that  hand, MNCs  of  proof  who happened t o f a i l t o conform t o t h e  l e n g t h p r i n c i p l e a r e t o o harsh.  taxpayers  as  there always  i s firm  prejudice  those  taxpayers. among t a x  have t h e v i c i o u s i n t e n t i o n t o  185 save t a x . seems  The MNCs are thought t o a v o i d or evade tax whenever i t  possible  However, that  to  escape  the  eyes  of  as the OECD Report suggests,  the  price  the  tax a u t h o r i t i e s .  " i t should not be assumed  a c t u a l l y charged w i t h i n an MNC  w i l l never be  an  43  arm's l e n g t h p r i c e . "  I t i s a q u e s t i o n o f f a c t and the d i f f e r e n c e  between " d i s h o n e s t " taxpayers one  t o make.  and  In other words,  t a x avoidance or e v a s i o n and  "honest" taxpayers  is  a  d i s t i n g u i s h i n g between the  hard  illegal  l e g i t i m a t e tax s a v i n g i s d i f f i c u l t .  R e a l i z i n g t h a t harsh tax treatments a g a i n s t "honest" MNCs i n a p a r t i c u l a r country may  eventually result i n  the  withdrawal  a c t i v i t i e s of the MNC  from t h a t  and  of  business  reduction  or  country,  even though i t might be i n a p p r o p r i a t e or i m p o s s i b l e t o  apply  d i s c r i m i n a t i v e treatment i n accordance w i t h the i n t e n t i o n s of the of  a  MNC,  taxpayers  it  might  be p o s s i b l e t o d i s c r i m i n a t e the  from the honest taxpayers  dishonest  at administrative l e v e l s .  the v e r y l e a s t , more prudent c o n s i d e r a t i o n should be g i v e n the course  o t h e r words, evidence  during  of the adjustment on the t r a n s f e r p r i c e i f the MNC  e s t a b l i s h t h a t i t had no i n t e n t i o n t o i f the MNC  can  avoid  establish  by  or  evade  documents  can  tax. or  In  other  t h a t i t made every e f f o r t t o conform t o the arm's l e n g t h  p r i n c i p l e when f i x i n g i n t r a - g r o u p p r i c i n g arrangements. Impact o f t a x r e v o l u t i o n i n t h e Mr.  At  U.S.  Ward s t a t e s :  As most of us will have observed, n a t u r a l laws of p h y s i c s i n d i c a t e t h a t water has a tendency t o flow from p l a c e s of h i g h e r l e v e l t o those which are lower. Tax administrators have a l s o observed a n a t u r a l law of i n t e r n a t i o n a l t a x a t i o n - the profit seems t o flow  186 naturally from those c o u n t r i e s where h i g h e r taxes a r e imposed t o those imposing lower l e v e l s o f t a x a t i o n . 44 Tax  authorities  i n developed c o u n t r i e s  t a c k l e t h e i n t e r n a t i o n a l t a x avoidance o r t h i s natural the  profits  tax  planning.  evasion  law o f i n t e r n a t i o n a l t a x a t i o n , t o t a x haven c o u n t r i e s  In 1986,  have been t r y i n g t o  i . e . , the s h i f t i n g of  by t r a n s f e r p r i c i n g o r other  f o r i n d i v i d u a l and c o r p o r a t e t a x p a y e r s were reduced  t o h a l f o r l e s s than h a l f o f those o f Canada o r i t can be s a i d t h a t t h e U.S.  Both Canada and Japan a r e a f r a i d t h a t would  follows  t h e U.S. I n t e r n a l Revenue Code d r a s t i c a l l y changed:  the t a x r a t e s  moment,  that  provide  more  incentives  Japan.  At  has become a "tax t h e U.S.  tax  this  haven".  revolution  f o r MNCs t o s h i f t t h e i r p r o f i t s  from r e l a t e d e n t i t i e s i n Canada o r Japan  t o t h e i r U.S. e n t i t i e s ,  u s u a l l y parent companies. In Canada, relationships  owing t o i t s  and  close  some people  concern t h a t most o f Canadian-based MNCs and wealthy  individuals  go  t h e U.S.  location  i n various aspects,  would  with  geographical  down t o t h e south o f border l o o k i n g  f o r more a f t e r - t a x  incomes. In  t h e meantime,  Japan  i s seriously  a d d i t i o n t o those new U.S. t a x i n c e n t i v e s , s t r o n g "yen"  and t r a d i t i o n a l l y s t r o n g U.S.  Japanese domestic p o l i c e s , l a r g e companies  shift  concerned  that i n  the recent devastating interference  i n the  would make most o f t h e l a r g e Japanese  not o n l y  their profits  but also  main  a c t i v i t i e s t o t h e U.S. At t h i s moment,  a new tax b i l l which would  reduce  Japan's  187 tax  rates  on  i n d i v i d u a l s and c o r p o r a t e taxpayers t o t h e almost  same l e v e l as those Japanese  Diet.  of  The  t h e U.S.  Ministry  of  i s being Finance  discussed of  i n the  Canada  i s also  p l a n n i n g t o propose a new t a x b i l l which has a s i m i l a r e f f e c t  as  those o f t h e U.S. and Japan. However,  u n t i l t h e above-mentioned l e g i s l a t i v e p r o p o s a l s t o  e q u a l i z e t a x r a t e s have been passed, will  have  to  prepare  Revenue Canada and t h e NTA  f o r t h e amount  and number o f t r a n s f e r  p r i c i n g m a n i p u l a t i o n s h i f t i n g p r o f i t s t o t h e U.S. by taxpayers i n t h e i r respective jurisdictions t o s i g n i f i c a n t l y  E f f e c t o f a g g r e s s i v e assessment  increase.  by t h e IRS  There have been rumors w i t h i n t h e t a x community t h a t t h e U.S. s u b s i d i a r i e s o f some Japan-based  in  Japan  MNCs a r e s u f f e r i n g  from h a r s h assessments  from t h e IRS u s i n g s e c t i o n 482 o f t h e IRC.  Those  r e q u e s t i n g competent a u t h o r i t y procedures,  MNCs,  without  have begun t o manipulate t h e i r t r a n s f e r p r i c i n g shift  more  profits  to  their  U.S.  subsidiaries  e s t a b l i s h m e n t s i n o r d e r t o s a t i s f y t h e IRS and taxation.  Such  rumors  expected  alleviate  double I f their  t h e MNCs  should  f u l l r e l i e f through t h e f o r e i g n t a x c r e d i t  and i f t h e i r double t a x a t i o n was n o t a l l e v i a t e d t a x c r e d i t system,  by  to  o r permanent  seem t o have r e a s o n a b l e b a s i s .  double t a x a t i o n a r e j u r i d i c a l double t a x a t i o n , have  arrangements  the  system foreign  s i n c e Japan d i d not have t h e t r a n s f e r p r i c i n g  t a x a t i o n l e g i s l a t i o n i n p l a c e and t h e MNCs c o u l d n o t expect  much  from mutual agreement procedures, i n some cases b e i n g assessed o f double  taxation  was b e t t e r than u n d e r t a k i n g expensive and time-  188 consuming c o u r t procedures. I t may not be describe IRS.  appropriate  the e f f e c t i v e  to  use t h e word  "harsh" t o  and i n t e n s i v e assessment e f f o r t s o f t h e  One s h o u l d r e c o g n i z e t h a t t h e IRS i s t h e most  the area  of  advanced  in  i n t e r n a t i o n a l a u d i t , and i t s o r g a n i z a t i o n and a u d i t  p e r s o n n e l a r e much b e t t e r than those o f t h e NTA o r Revenue Canada i n terms o f q u a n t i t y , q u a l i t y and budget. As a c o r o l l a r y o f t h e n a t u r a l law o f i n t e r n a t i o n a l "harsh" o r  aggressive  principle,  should  assessments  cause  by  t h e MNCs  taxation,  the tax authority,  shift  their  profits  a c t i v i t i e s t o o t h e r c o u n t r i e s which a r e more generous  about  in and the  MNCs' a g g r e s s i v e t a x p l a n n i n g , i . e . , such as t a x haven  countries,  or  principle,  escape t o "underground economy".  Contrary t o t h i s  the IRS•s i n t e n s i v e enforcement o f t h e t r a n s f e r p r i c i n g system  seems  augmenting  to  succeed  i n keeping  t a x compliances  of  and  raising  t h e MNCs.  This  taxation revenue by  exceptional  phenomenon might be e x p l a i n e d by t h e f a c t t h a t t h e U.S. market i s by f a r t h e most important and p r o f i t a b l e market f o r most MNCs and even b e f o r e t h e U.S.  became a "tax haven",  t h e IRC had a number  o f tempting l o o p h o l e s . This Even i f  c r e a t e s a dilemma i t i s important  f o r both Revenue Canada and t h e NTA.  f o r them  t o strengthen  their  ability  e n f o r c i n g t r a n s f e r p r i c i n g t a x a t i o n system more e f f e c t i v e l y , they should be aware t h a t t h e i r e f f o r t s w i l l their  coffers  reduce  t h e revenue  to  i n t h e l o n g r u n u n l e s s t h e i r t a x laws become more  advantageous f o r MNCs than those o f t h e U.S.  189  4.  FINAL  REMARKS  I t seems t o me t h a t we cannot expect b e t t e r t r a n s f e r p r i c i n g t a x a t i o n l e g i s l a t i o n than those we important length  to  provide  principle  have  to  taxpayers,  calculation  of  usefulness  since  an arm's l e n g t h p r i c e i s a q u e s t i o n  argument  about  transfer  i t is  p r e f e r a b l y i n t h e form o f law,  be l i m i t a t i o n s o f i t s  reasonable  While  d e t a i l e d g u i d e l i n e s implementing t h e arm's  t h e r e should  as t h e  already.  capital  pricing  gains  or  taxation  prudent and f l e x i b l e enforcement by  actual  o f f a c t such  business  system  tax  an  income.  would  authorities  A  depend on and  self-  r e s t r a i n e d manner i n f i x i n g t r a n s f e r p r i c e s by t h e MNCs. As  the  considerations  NTA adopted as i t s b a s i c p r i n c i p l e s , should  be  strictly  observed  the following by  the  tax  authorities: (a)  To  neutralize,  as  much  as  possible,  t r a n s f e r p r i c i n g t a x a t i o n on l e g i t i m a t e activities,  To  minimize  taxpayers, and  excessive  bearing  decisions  and  compliance o f t a x p a y e r s ;  and c o s t l y a d m i n i s t r a t i v e burdens on  while securing information  r e a s o n a b l e t a x adjustments.  Tax  economic  e f f e c t of the  and t o secure a f a i r and reasonable assessment, which  can ensure long-term v o l u n t a r y (b)  the  a u t h o r i t i e s should t h e golden eggs.  essential for fair,  just  45  be c a r e f u l not t o k i l l  t h e goose t h a t  190  CHAPTER IV - FOOTNOTES  1  J . R. Robertson, A Revenue Canada P e r s p e c t i v e on I n t e r n a t i o n a l T a x a t i o n : T r a n s f e r P r i c i n g and R e l a t e d I s s u e s , Report o f the Proceedings o f the T h i r t y - F o u r t h Tax Conference. Canadian Tax Foundation (1982), a t 777  2  D. L. H. Davidson, Advance R u l i n g and Interpretation Bulletins, Report o f the Proceedings o f the T h i r t y - F i f t h Tax Conference. Canadian Tax Foundation (1983), a t 797  3  R. M. B e i t h , Advance R u l i n g s : A d m i n i s t r a t i o n and P r i n c i p l e s , Report o f t h e Proceedings of the Thirty-Fourth Tax Conference. Canadian Tax Foundation (1982), a t 457  4  Ibid.  457  5  Ibid.  459  6  I b i d . 459  7  Supra. note 2, a t 796  8  Supra, note 3, a t 459  9  Supra. note 2, a t 459  10  See page  11  See page 43-45  12  See page  13  See page 18  14  N. Boidman, Canada-US Intercompany (and other) T a x a t i o n Issues, Report o f t h e Proceedings o f the T h i r t y - F i f t h Tax Conference. Canadian Tax Foundation (1983), a t 323  15  The U.S. IRC R e g u l a t i o n 1 . 4 8 2 - 2 ( e ) ( 1 ) ( i v )  16  T r a n s f e r P r i c i n g and M u l t i n a t i o n a l E n t e r p r i s e s , Report o f the OECD Committee on F i s c a l A f f a i r s (1979), a t p a r a . 41  17  Supra. note 1, a t 777  18  Supra, note 1, a t 777  19  Revenue  148-149  148-149  Canada,  International  Transfer  Pricing  and o t h e r  191 I n t e r n a t i o n a l T r a n s a c t i o n s , I n f o r m a t i o n C i r c u l a r 87-2 a t p a r a . 10  (1987),  20  Supra, note 1, a t 777  21  Supra, note 19, a t p a r a . 11  22  Supra, note 16, a t p a r a . 63 and  23  Supra, note 16, a t p a r a . 70  24  Supra. note 16, a t p a r a . 38  25  See page  26  Transfer Pricing, Corresponding Adjustments and the Mutual Agreement Procedure, Transfer Pricing and Multinational Enterprises: Three T a x a t i o n I s s u e s . Report o f the OECD Committee on F i s c a l A f f a i r s (1984), a t subpara. 116(iv)  27  J . A. Calderwood, A Revenue Canada P e r s p e c t i v e on the Role and Method o f O p e r a t i o n o f the "Competent A u t h o r i t y " , Report of the Proceedings o f the T h i r t y - S i x t h Tax Conference, Canadian Tax Foundation (1984), a t 324  28  The simultaneous examination program on a l s o s t a r t e d i n 1983.  29  Supra. note 27, a t 325  30  Supra. note 27, a t 325-326  31  P. E. Coates, The Role and O p e r a t i o n o f the US Competent Authority, Report o f the Proceedings o f the T h i r t y - S i x t h Tax Conference. Canadian Tax Foundation (1984), a t 331-332  32  Supra, note 27, a t 326  33  Supra. note 27, a t 32 6  34  Supra, note 31, a t 332  35  Supra. note 27, a t 320 and  36  Supra, note 26, a t p a r a .  37  T. K i r i b u c h i , Japan's T r a n s f e r P r i c i n g T a x a t i o n : I n t r o d u c t i o n and Enforcement. International Tax Institute Seminar on T r a n s f e r P r i c i n g T a x a t i o n (1986), a t p a r a . 22  38  See page  39  Supra. note 38, a t p a r a . 21  70  152  criminal  cases  has  323  105  192  40  Supra, note 16, a t p a r a . 15 and 25  41  J . S. Peterson, I n t e r n a t i o n a l T r a n s f e r P r i c i n g : A Canadian Perspective, Report o f t h e Proceedings o f t h e T h i r t y - F i r s t Tax Conference, Canadian Tax Foundation (1979), a t 463-464  42  Supra. note 16, a t p a r a . 3  43  Supra, note 16, a t p a r a . 38  44  D. A. Ward, P r i c i n g and I n t e r n a t i o n a l T r a n s a c t i o n s , Report o f the Proceedings o f Twenty-Eighth Tax Conference. Canadian Tax Foundation (1976), a t 130-131  45  Supra. note 38, a t p a r a . 18  193  SELECTED BIBLIOGRAPHY Book Plasschaert, S. R. F., T r a n s f e r P r i c i n g and M u l t i n a t i o n a l C o r p o r a t i o n : an overview o f concepts, mechanisms and r e g u l a t i o n s , (U.K.: Saxon House, 1977)  Reports IRS Could B e t t e r P r o t e c t U.S. Tax I n t e r e s t i n Determining t h e Income o f M u l t i n a t i o n a l C o r p o r a t i o n s . Report t o t h e Chairman o f the House Committee on Ways and Means (Washington,D.C.: The U.S. General A c c o u t i n g O f f i c e , 1981) Model Double T a x a t i o n Convention on Income and on C a p i t a l . Report of t h e OECD Committee on F i s c a l A f f a i r s ( P a r i s : OECD, 1977) Outline o f Japanese Taxes 1986. Tax Bureau o f t h e M i n i s t r y o f Finance (Tokyo: P r i n t i n g Bureau, 1986) T r a n s f e r P r i c i n g and M u l t i n a t i o n a l E n t e r p r i s e s . Report OECD Committee on F i s c a l A f f a i r s ( P a r i s : OECD, 1979)  of the  Transfer P r i c i n g and M u l t i n a t i o n a l E n t e r p r i s e s : Three I s s u e s . Report o f t h e OECD Committee on F i s c a l Affairs OECD, 1984)  Taxation (Paris:  A r t i c l e s and Monographs Baxter, G. C. and Konopka, R. A., T r a n s f e r P r i c i n g A c r o s s t h e Canada-US Border (1985), June CA Magazine 50 Beith, R. M., Advance R u l i n g s : A d m i n i s t r a t i o n and P r i n c i p l e s , Report o f t h e Proceedings o f t h e T h i r t y - F o u r t h Tax Conference (Canadian Tax Foundation, 1982) 456  194  Boidman, N., Canada-US Intercompany (and other) T a x a t i o n Issues, Report o f the Proceedings o f the T h i r t y - F i f t h Tax Conference (Canadian Tax Foundation, 1983) 312 Calderwood, J . A., A Revenue Canada P e r s p e c t i v e on the Role and Method o f O p e r a t i o n o f the "Competent A u t h o r i t y " , Report o f the Proceedings o f the T h i r t y - S i x t h Tax Conference (Canadian Tax Foundation, 1984) 315 Coates, P. E., The Role and O p e r a t i o n o f the U.S. Competent Authority, Report o f the Proceedings o f the T h i r t y - S i x t h Tax Conference (Canadian Tax Foundation, 1984) 327 Davidson, D. L. H., Advance R u l i n g and I n t e r p r e t a t i o n Report o f t h e Proceedings o f the T h i r t y - F i f t h Tax (Canadian Tax Foundation, 1983) 795  Bulletins, Conference  H a r r i s , E. C., Intercompany Cross-border T r a n s a c t i o n s : A Growing Concern f o r Revenue Canada (1985), June CA Magazine 22 Kiribuchi, T., Japan's T r a n s f e r P r i c i n g T a x a t i o n : introduction and Enforcement (1986), I n t e r n a t i o n a l Tax I n s t i t u t e Seminar on Transfer P r i c i n g Taxation Peterson, J . S., International Transfer Pricing: A Canadian Perspective, Report o f the Proceedings o f the T h i r t y - F i r s t Tax Conference (Canadian Tax Foundation, 1979) 451 Robertson, J . R., A Revenue Canada P e r s p e c t i v e on I n t e r n a t i o n a l Taxation: Transfer P r i c i n g and R e l a t e d I s s u e s , Report o f the Proceedings o f the T h i r t y - F o u r t h Tax Conference (Canadian Tax Foundation, 1982) 773 Tamaki, G. T. and Pound, R. W., Intercompany P r i c i n g : In Search of G u i d e l i n e s (1974), 22 Canadian Tax J o u r n a l 460 Tillinghast, D. R., An American View o f I n t e r n a t i o n a l Intercompany P r i c i n g Problems, Report o f the Proceedings o f the T h i r t y - F i r s t Tax Conference (Canadian Tax Foundation, 1979) 469 Ward, D. A., P r i c i n g and I n t e r n a t i o n a l T r a n s a c t i o n s , Report of the Proceedings o f the Twenty-Eighth Tax Conference (Canadian Tax Foundation, 1976) 130  195  A r t i c l e s and Monographs (Japanese Text) Kaneko, H., Arm's Length P r i n c i p l e i n Income T a x a t i o n i n the U.S.(1980-81), 724. 734 and 736 J u r i s t (Tokyo: Yuhikaku) #724104, #734-56, #736-95 Odajima, S., T r a n s f e r P r i c i n g T a x a t i o n System (1986), Special Issue - I n t e r n a t i o n a l T a x a t i o n (Tokyo: Kokusai-zeimu-kenkyukai) 24 Thomas, G. M., Recent Issues Concerning the Enforcement of S e c t i o n 482 o f the US I n t e r n a l Revenue Code (1982), May I n t e r n a t i o n a l T a x a t i o n (Tokyo: Kokusai-zeimu-kenkyukai) 20 Thomas, G. M. and Aramaki, K., Transfer Pricing Legislation (1986), S p e c i a l Issue - I n t e r n a t i o n a l T a x a t i o n (Tokyo: Kokusaizeimu-kenkyukai) 4  Cases Canadian General E l e c t r i c (1982) D.T.C. 6232  Company L t d . v.Her Majesty The Queen  C e n t r a l Canada F o r e s t Product Revenue (1952) D.T.C. 359  Ltd.  v.  Minister  of  National  C o n s o l i d a t e d B a t h u r s t L t d . v. Her Majesty The Queen (1985) D.T.C. 5120 Dominion B r i d g e Co. 5150  L t d . v.  Her M a j e s t y The Queen v. L t d . (1980) D.T.C. 6272  Her Majesty The Queen (1975) D.T.C.  S a i n t John S h i p b u i l d i n g & Dry Dock  Indalex L t d . v. Her Majesty The Queen (1986) D.T.C. 6039  Co.  196  J . H o f e r t L t d . v. M i n i s t e r o f N a t i o n a l Revenue (1962) D.T.C. 50 Porta-Test 6046  System  Ltd.  v.  Her Majesty The Queen (1980) D.T.C.  Regina v. Redpath I n d u s t r i e s L t d . (1983) D.T.C. 5117 Spur O i l L t d . v. Her Majesty The Queen (1981) D.T.C. 5168 S t u b e r t Investments L t d . v. 6305  Her Majesty The Queen (1984)  D.T.C.  Revenue Canada's P u b l i c a t i o n Interpretation  Bulletin  IT-303  Know-How and S i m i l a r Payments t o Non-Residents  IT-468  Management o r A d m i n i s t r a t i o n Fees P a i d t o Non-Residents  Information C i r c u l a r 70- 6R  Advance  Income Tax R u l i n g s  71- 17R2  Requests f o r "Competent Taxation Issues  A u t h o r i t y " C o n s i d e r a t i o n - Double  76-12R2 A p p l i c a b l e Rate o f P a r t X I I I Tax on Amounts P a i d C r e d i t e d t o Persons i n T r e a t y C o u n t r i e s 87-2  International Transfer Pricing Transactions  and  Other  or  International  197 I n t e r n a l Revenue S e r v i c e ' s P u b l i c a t i o n Revenue Procedure 65-17  T e c h n i c a l P o s i t i o n and Procedure Governing t h e Adjustment of Accounts and t h e T r a n s f e r o f Amounts as t h e R e s u l t o f Allocations o f Income o r Deductions made pursuant t o s e c t i o n 482 o f t h e I n t e r n a l Revenue Code o f 1954  70-18  Procedure A p p l i c a b l e t o R e s o l v i n g Issues I n v o l v i n g the Allocation o f Income and Deductions Between R e l a t e d E n t i t i e s under U n i t e d S t a t e s Income Tax T r e a t i e s  S t a t u t e s and R e g u l a t i o n s Canada The Income Tax A c t  S.C. 1970-71-72, c. 63, as amended  The Income Tax R e g u l a t i o n s  C.R.C. 1978, c.945, as amended  Japan The C a b i n e t Order Implementing t h e General Law o f N a t i o n a l 1962, C a b i n e t Order #135, as amended The C o n s t i t u t i o n o f Japan The C o r p o r a t i o n Tax Law  1946 1965, Law #34, as amended  The C o r p o r a t i o n Tax Law Enforcement #97, as amended The General Law o f N a t i o n a l Taxes The Income Tax Law  Taxes  Order  1965,  Cabinet  1962, Law #66, as amended  1965, Law #33, as amended  Order  198  The Law f o r Enforcement o f Tax T r e a t i e s 1969, Law #46, as amended The M i n i s t e r i a l Ordinance Implementing t h e Law f o r Enforcement o f Tax T r e a t i e s 1969, Finance and Home A f f a i r s M i n i s t e r i a l Order #1, as amended The S p e c i a l T a x a t i o n Measures  Law  1957, Law #26, as amended  The S p e c i a l T a x a t i o n Measures Order #43, as amended  Law Enforcement Order 1957, Cabinet  The S p e c i a l T a x a t i o n Measures Law Enforcement Finance M i n i s t e r i a l Order #15, as amended  Regulations  1957,  U.S. The I n t e r n a l Revenue Code  1954, ch. 736, 68A S t a t . 3, as amended  The Income Tax R e g u l a t i o n s 1954, as amended  

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