The Discretionary Nature of Downward Transfer-Pricing Adjustments

The situation outlined in TeleTech Canada, Inc. v. Canada (National Revenue) (2013 FC 572) serves as an important reminder to Canadian taxpayers that the availability of relief from double taxation in a transfer-pricing context cannot always be taken for granted, particularly in cases where such relief takes the form of a downward transfer-pricing adjustment, the application of which is subject to the minister's discretion.

Subsection 247(2) of the Act allows the minister to adjust the value of transactions with non-arm's-length non-residents in order to reflect prices that would have applied in arm's-length situations. If, for example, a particular transaction is determined to have resulted in excessive amounts of income having been subject to tax in Canada and, conversely, in insufficient amounts of income having been subject to tax in a foreign jurisdiction, an upward adjustment to the income in the foreign jurisdiction may be warranted. If the CRA does not permit a corresponding downward adjustment, double taxation may result. At the very least, excessive taxation may arise, even when the upward adjustment in the foreign jurisdiction results in no additional tax liability due to the existence of tax attributes that are available to offset the additional income.

In the TeleTech decision, the taxpayer sought to correct what it asserted to be an improper allocation of income and expenses between entities in Canada and the United States which, it said, caused Canadian profits to be "dramatically overstated" and US profits to be "dramatically understated." To rectify this matter, a letter requesting a downward transfer-pricing adjustment was sent to the CRA, and TeleTech US amended its US tax returns to increase its income by a corresponding amount. After nearly two years without a response from the CRA, the request for a downward adjustment was withdrawn in favour of a request for competent authority assistance under the Canada-US income tax treaty. The CRA declined the competent authority request because the IRS had not yet assessed the amended returns of TeleTech US, and thus no double taxation had arisen.

Later actions by the IRS resulted in additional upward adjustments from a US perspective and in additional requests for competent authority relief. The taxpayer ultimately applied for judicial review of the CRA's alleged "continuing refusal" to grant relief. The application was denied by the FC.

This case highlights the potentially negative consequences that can arise because Canadian domestic law and administrative guidance do not require the minister to accept a downward transfer-pricing adjustment even where a corresponding upward adjustment is ultimately applied in a foreign jurisdiction. Specifically, according to subsection 247(10) of the Act, downward transfer-pricing adjustments will be accepted if, "in the opinion of the Minister, the circumstances are such that it would be appropriate that the adjustment be made." Administrative guidance on this provision, which is set out in Information Circular 87-2R and further clarified in Transfer Pricing Memorandum TPM-03, describes certain situations in which the minister may decide not to exercise her discretion under subsection 247(10). Specifically, paragraph 26 of IC 87-2R provides that a request for a downward adjustment may not be accepted if "the taxpayer's request has been prompted by the actions of a foreign tax authority and the taxpayer has the right to request relief under the Mutual Agreement Procedure article of the applicable treaty; or the taxpayer's request can be considered abusive." These examples are not an exhaustive list, however, and ultimately the minister is not obligated to provide any specific justification for the rejection of a downward adjustment request.

The lack of any guarantee that the minister will accept a request for a downward adjustment is a further incentive for taxpayers to prevent the need for such requests in the first place by carefully considering and regularly monitoring the terms and conditions (including prices) of transactions with related non-resident entities.

Alex Evans
Deloitte LLP, Burlington

Canadian Tax Focus
Volume 3, Number 4, November 2013
©2013, Canadian Tax Foundation