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Latam Mining & Metals Tax Forum Transfer Pricing An Evolving Landscape

Sean Kruger

May 2017

Latest on the OECD’s BEPS initiative

OECD / G20 BEPS Project

What is BEPS?

► According to the OECD, “BEPS refers to tax planning

strategies that exploit…gaps and mismatches in tax rules to

artificially shift profits to low or no-tax locations where there

is little or no economic activity, resulting in little or no overall

corporate tax being paid.”

► Artificially shifting profit between countries leading to erosion

of the tax base where the economic activity to create the

profit occurred

► Global problem requiring global solutions

Brief overview of final BEPS deliverables

► Action 1: Address the tax challenges of

the digital economy

► Action 2: Neutralise the effects of hybrid

mismatch arrangements

► Action 3: Designing effective CFC rules

► Action 4: Limit base erosion via interest

deductions and other financial payments

► Action 5: Counter harmful tax practices

more effectively, taking into account

transparency and substance

► Action 6: Prevent treaty abuse

► Action 7: Prevent the artificial avoidance

of permanent establishment status

► Action 8: Consider transfer pricing for

intangibles

► Action 9: Consider transfer pricing for risks and

capital

► Action 10: Consider transfer pricing for other

high-risk transactions

► Action 11: Establish methodologies to collect

and analyse data on BEPS and actions

addressing it

► Action 12: Require taxpayers to disclose

their aggressive tax planning arrangements

► Action 13: Re-examine transfer pricing

documentation

► Action 14: Making dispute resolution

mechanisms more effective

► Action 15: Develop a multilateral

instrument for amending bilateral tax

treaties

Final reports on Actions 8-10 and Action 13 were formally adopted by the OECD Guidelines on 23 May 2016

Action 13: Transfer pricing documentation and country-by-country reporting

Country-by-country

reportHigh-level information about the

jurisdictional allocation of revenues,

profits, taxes, assets and employees

of a multinational corporation (MNC)

to be shared with all tax authorities

where the MNC has operations

Master fileHigh-level information about a

MNC’s business, transfer pricing

policies and agreements with tax

authorities in a single document

available to

all tax authorities where the MNC

has operations

Local fileDetailed information about a MNC’s

local business, including related-

party payments and receipts for

products, services, royalties,

interest and so on

New

RedefinedRedefined

Tax authorities will have access to taxpayers’ global tax footprint via

CbC reporting data, master file and the local file

Action 13: Country-by-country reporting

Country-by-country reporting:

► Reporting required by MNCs with

revenue of Euro 750 million or more

► To be implemented for fiscal years

beginning on or after 1 January 2016

► Generally to be filed in country of tax

residence of ultimate parent entity and

shared with other countries through

automatic exchange of information

► Aggregate country information on

revenues, profits, cash taxes, accrued

taxes, stated capital, accumulated

earnings, employees and tangible assets

What happened Status

► Approximately 44 jurisdictions have

adopted or have legislation in draft to

adopt CbC reporting


adopted or have legislation in draft to

adopt notification requirements, with the

first requirements due on December 31,

2016 for Denmark, Ireland and Spain


signed the Multilateral Competent

Authority Agreement for the automatic

exchange of CbC reports

CbC report

What it is:

A new information reporting requirement, required for fiscal

years starting in 2016, in the form of a table showing data,

aggregated by country, on an MNC group’s revenues, profits,

taxes, assets and employees. Table is to be shared with all

countries where MNC operates.

What it is not:

Not intended as a substitute

for a full transfer pricing

analysis. Also not intended

for use in making formulary

apportionment-based

adjustments.

Why this is an early focus:

Because of the complexities involved with

cross-border transactions and data

collection and management, many

companies should begin preparing now

by testing and validating processes and

technologies. This allows time to take

mitigating steps – e.g., ensuring profit

margin consistency and minimizing

potential controversy.

Master

file

Local

file

CbC

report

Preparing

for CbC

reporting

Country-by-Country Report

► Detailed information about MNE’s local business, including related party payments and receipts for

products, services, royalties, interest, etc.

► High level information about jurisdictional allocation of profits, revenues, employees and assets.

Tax

Jurisdiction

RevenuesProfit (loss)

Before

Income Tax

Cash Tax Paid

(CIT and WHT)

Current Year

Tax AccrualStated

capital

Accumulated

earnings

Tangible

Assets other

than Cash

and Cash

Equivalents

Number of

EmployeesUnrelated

party

Related

partyTotal

1.

2.

3.

4.

5.

Tax

Jurisdiction

Constituent

Entities

resident in

the Tax

Jurisdiction

Tax

Jurisdiction of

organization or

incorporation if

different from

Tax

Jurisdiction of

Residence

Main business activity(ies)

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Where is your organization?

Assessment

► Country-by-Country

Reporting Assessment Tool

► Data mapping

► Systems gap analysis

► Assess existing reporting

suitability

► Road map, timeline and

business case

Phase 1Implementation

► Solution design utilizing

Country-by-Country

Reporting Management Suite

► Tax sensitization

► Data gathering

► Analytics and reporting

► Controls

► Workflow solution

Phase 2

Reporting

► Preparation and maintenance

of reports with audit trail

► Consistency among master

and local files and country-by-

country reporting outputs

► High level of finance and tax

coordination

► Operational compliance

management

Phase 3

Country-by-Country ReportKey data points: Current understanding of definitions

► Related party revenue

► Includes: related party revenues from net sales

revenues, services fees, royalties income, interest and

other finance income

► Excludes: intercompany dividends and gains on disposal

of assets (unless that is part of the entities’ general

operations)

► Use Transfer Pricing Guidelines definition of associated

to determine related parties

► Unrelated party revenue

► Includes: unrelated party revenues from net sales

revenues, services fees, royalties income, interest and

other finance income

► Excludes: gains on disposal of assets (unless that is part

of the entities’ general operations)

► Profit (loss) before income tax

► Earnings (profit or loss) before income tax for tax

purposes, including extraordinary items

► For the sake of consistency when analyzing profit

margins, intercompany dividends received should be

excluded.

► Income tax paid

► Amounts paid by the reporting entity to the residence tax

jurisdiction and all other tax jurisdictions, as well as taxes

withheld by other entities on income received by the

reporting entity

► Income tax accrued (current year)

► The tax charge in the P&L relating to the current year

► Should not include deferred taxes or provisions for

uncertain liabilities

► Stated capital

► Sum of the stated capital for all reporting entities

► Accumulated earnings

► Sum of all accumulated earnings for all reporting entities

as of the end of the year

► Number of employees

► The total number of employees on a full-time equivalent

(FTE) basis

► May be reported based on year-end number, average

employment levels for the year, or on any other basis

consistently applied across countries and from year to

year

► Include full-time equivalent independent contractors

► Tangible assets other than cash & cash equivalents

► Includes: tangible assets such as plant, property,

machinery, fixtures and fittings, computer equipment and

inventory

► Excludes: cash and cash equivalents and financial

assets

► Treatment of software would depend on group treatment

(i.e., sometimes a tangible asset sometimes an

intangible)

BEPS Current Issues

Action 13 Current Issues Matrix

► Country-by-Country

Reporting (“CbC”)

► CbC Required

► Threshold for CbC

► Due Date

► Penalties

► Notification Requirements

► Ultimate Parent Entity

► Surrogate Parent Entity

► Constituent Entity

► Notification Date

► Master file / Local file (“MF/LF”)► MF/LF Required

► Threshold for MF/LF

► MF/LF requirements different from those

outlined in Action 13

► Due Date

(if no MF/LF is required, then the due date

corresponds to the date of local TP

documentation within that specific country)

► Due date for FY2016

(FYE: December 31, 2016)

► Penalties

The latest on BEPS OECD’s Additional Guidance

► The OECD released

additional guidance on

April 6, 2017 covering the

following: 1) Issues relating to the definition of

items reported in the template for

the CbC report

2) Issues relating to the entities to be

reported in the CbC report

3) Issues relating to the filing

obligation for the CbC report

4) Issues relating to the sharing

mechanism for the CbC report

(EOI, surrogate filing and local

filing)

OECD’s Additional Guidance Definitions

► Revenues

► Extraordinary income and gains from investment activities are to be

included in "revenues”

► Related parties

► For the third column of Table 1 of the CbC report, the related parties,

which are defined as “associated enterprises” in the Action 13 report,

should be interpreted as the Constituent Entities (“CE”) listed in Table 2 of

the CbC report

The Related Parties reflected in Table 1 correspond to the

Constituent Entities reflected in Table 2

OECD’s Additional Guidance Definitions

1) Determining the existence of and membership of a group► The guidance specifies that a group can use the consolidation rules of accounting

standards already used by the group if the equity interests of the UPE are traded on a public securities exchange

► Other options are provided for in cases where equity interests of the UPE are not publicly traded, here jurisdictions may allow the MNE to choose to use either local GAAP of the jurisdiction of the UPE or the IFRS as its governing accounting standard

2) How to apply CbC rules to investment funds► Governing principal is to follow the accounting consolidation rule

3) How to treat a partnership which is tax transparent (no tax residency)► Governing principal is to follow the accounting consolidation rule (rules that would

apply for partnerships)

► If the entity is not a tax resident and not a PE, the entity should be included in a line for Table 1 and 2 for “stateless entities”

► Where the partnership is a UPE, to determine where to file, use the jurisdiction under whose laws the partnership was formed (if there is no jurisdiction for the tax resident)

OECD’s Additional Guidance Entities to be reported in the CbC report

4) Minority interests held by unrelated parties in a CE: (i) to

determine €750 million threshold, do you include 100% of CE

revenue or pro-rata; and (ii) do you include 100% of CE financial

data in CbC report or pro-rata

► If accounting rules in the jurisdiction of the UPE require a CE to be fully

consolidated then 100% of the CE’s revenue should be included

► If 100% of the CE’s revenue is included in (i) then 100% of the CE’s

financial data should be included in the CbC Report

OECD’s Additional Guidance Entities to be reported in the CbC report

1) Impact of currency on €750 million filing threshold

“If Country A is using a domestic currency equivalent of EUR 750 million for its filing threshold, Country B is using EUR 750 million for its filing threshold, and as a result of currency fluctuations Country A's threshold is in excess of EUR 750 million, can Country B impose its local filing requirement on a Constituent Entity of an MNE Group headquartered in Country A which is not filing a CbC report in Country A because its revenues, while in excess of EUR 750 million, are below the threshold in Country A?”

► Provided that the jurisdiction of the Ultimate Parent Entity has implemented a reporting threshold that is a near equivalent of EUR 750 million in domestic currency as it was at January 2015, an MNE Group that complies with this local threshold should not be exposed to local filing in any other jurisdiction that is using a threshold denominated in a different currency

OECD’s Additional Guidance The filing obligation for the CbC report

2) To determine total consolidated group revenue for the “threshold

test”, do you include extraordinary income and gains from

investment activities

► Yes, if those items are presented in the UPEs consolidated financial under

the applicable accounting rules

OECD’s Additional Guidance The filing obligation for the CbC report

1) “Can MNE Groups with an Ultimate Parent Entity resident in a jurisdiction

whose CbC reporting legal framework is in effect for Reporting Periods later

than 1 January 2016 voluntarily file the CbC report for fiscal periods

commencing on or from 1 January 2016 in that jurisdiction? What is the impact

of such filing on local filing obligations in other jurisdictions?”

► Gives rise to a transition issue.

► Jurisdictions that are not be able to implement CbC from 1 January 2016 may be

able to accommodate voluntary filing for UPE residents in their jurisdiction. This is

referred to as “parent surrogate filing” since it is a form of surrogate filing and the

framework is set out in the Action 13 Report

► No impact re: local filing obligations (subject to 5 conditions)

► Following jurisdictions have confirmed that they will have parent surrogate filing

available for UPE residents in their jurisdictions:

► Hong Kong & China

► Japan

► Liechtenstein

► Nigeria

OECD’s Additional Guidance Sharing mechanism for the CbC report

► Russian Federation

► Switzerland

► United States

Upcoming DeadlinesAction 13

Country Documents Due Date(s)

Sweden CbCR, LF

CbCR Notification deadline: April 30, 2017

MF: December 31, 2017

LF: July 1, 2017

Prepared at the time of the submission of the annual income tax

return. In terms of Sweden local TP doc, final documentation

should be available upon request from the Swedish Tax Agency.

Such a request is possible from the date the income tax return is

filed.

Finland CbCR, MF/LF

CbCR Notification deadline: May 31, 2017

MF / LF deadline: Within 60 days of a request by the tax

authorities, but not earlier than six months after the end of the

financial period (for example, deadline is June 30 assuming a

Dec 31 year end)

Portugal CbCR CbCR Notification deadline: May 31, 2017

Upcoming DeadlinesAction 13

Country Documents Due Date(s)

China MF/LF, CbCR

CbCR: To be filed together with the annual tax return (due 31

May).

MF/LF deadline: Upon request. MF should be ready within 12

months after the close of the financial year of the ultimate parent

company. LF should be ready before 30 June of the following

year (assuming Dec 31 year end).

Caveat: If the UPE is filing in another country, don't have to

follow China's CbCR deadline

Indonesia MF/LF, CbCR

CbCR: Must be filed along with the corporate income tax return.

MF/LF deadline: 4 months after fiscal year end

Colombia CbCRCbCR Notification deadline: May 31, 2017

MF/LF deadline: July 1, 2017

Turkey MF/LF MF/LF deadline: July 25, 2017

BEPS Action 10Commodity Transactions

Action 10 – Transfer Pricing for other high risk transactions: Commodity Transactions

► The use of the CUP method for pricing commodity transactions and the use of

quoted prices in applying the CUP method is recommended

► CUP method would generally be the most appropriate transfer pricing method

for determining the arm’s length price for controlled commodity transactions

► The arm’s length price for the controlled commodity transaction can be

determined, not only by reference to comparable uncontrolled transactions,

but also by reference to a quoted price. The term “quoted price” refers to the

commodity price in the relevant period that is obtained from an international or

domestic commodity exchange market. A quoted price also includes prices

obtained from recognized and transparent price reporting, statistical agencies

or from governmental price-setting agencies, where such sources are used as

a reference by unrelated parties to determine prices.

► A relevant factor in determining the appropriateness of using a quoted price is

the extent to which such price is widely and routinely used in the industry to

negotiate prices between third parties. For the CUP method to be reliably

applied, the economically relevant characteristics of the controlled

transactions and the third party transactions represented by the quoted price

need to be comparable.


► The economically relevant characteristics that need to be considered to

establish comparability include:

► Physical features and quality of the commodity

► The contractual terms of the controlled transaction, such as volumes

traded, period of the arrangements, timing and terms of delivery,

transportation, insurance, and foreign currency terms

► Certain economically relevant characteristics may lead to either a

premium or a discount.

► Adjustments should be made to ensure that the economically relevant

characteristics of the transactions are comparable. The final guidance

includes the very important statement that when applying a CUP,

contributions made in the form of functions performed, assets used and risks

assumed by other entities in the supply chain should be compensated in

accordance with the guidance provided in the TP Guidelines. Although the

remuneration of other parties in the value chain in practice can be significant,

limited guidance is provided on how to apply this in practice.


Deemed pricing date for commodity transactions

► When using quotations to price the commodity transaction, the pricing date is

a particularly relevant factor.

► When the taxpayer can provide reliable evidence of the pricing date agreed in

the controlled transaction at the time the transaction was entered into and this

is consistent with the actual conduct of the parties, the tax administrations

should determine the price for the commodity transaction by reference to the

pricing date agreed by the associated enterprises. If the pricing date agreed

by associated enterprises is inconsistent with the actual conduct of the parties

or with other facts of the case, tax authorities may determine a different

pricing date consistent with the evidence provided by those other facts.

► In the absence of reliable evidence of the actual pricing date agreed by the

associated enterprises, tax administrations may deem the pricing date for the

commodity transaction to be the date of shipment as evidenced by the bill of

lading or equivalent document.

Assessing risk in your existing operating model given BEPS

Actions 8–10

Six interlinked sections all of which impact risk management

► Guidance for applying the arm’s-length principle

► Guidance on commodity transactions

► Guidance on the transactional profit split method

► Guidance on intangibles

► Guidance on low value-adding intra-group services

► Guidance on cost contribution arrangements

Aligning transfer pricing outcomes with value creation

Actions 8–10 Summary

Assure that transfer pricing outcomes are in line with value creation

Action 8: Intangibles

Wider and clearer definition of

“intangibles”

Introduction of a six step

framework to analyse transfer

pricing aspects of intangibles

Legal ownership alone does not

generate a right to the return

generated by the exploitation of

an intangible

Focus on Development,

Enhancement, Maintenance,

Protection and Exploitation

(“DEMPE”) functions

Hard-to-Value Intangibles

(“HTVIs”)

Cost-Contribution Arrangements

(“CCAs”)

Action 10: Other high-risk

transactions

Intra-group services / low value-

add services

Profit Splits (additional discussion

draft issued in 2016)

Recognition of transactions

Commodity transactions

Action 9: Risk and Capital

Focus on conduct of parties and

their capability and functionality to

manage risks. Assumption of risk

without ‘control’ over that risk is

likely to be problematic

Separate consideration regarding

an appropriate return to any cash

investment

Introduction of a six step

framework to analyse risks for

transfer pricing purposes

Actions 8–10

Revisions to Section D of Chapter I of the TP guidelines following Actions 9 and 10.

Key guidance includes:

► Assess reasonableness of transfer pricing based on the actual conduct of the parties

versus contractual terms and conditions

► Detailed guidance – six-step approach – on analyzing risks as integral part of a

functional analysis

► Cash boxes will attain no more than a risk-free return at best

► In exceptional circumstances of commercial irrationality, a tax administration may

disregard the actual transaction

Guidance for applying the arm’s-length principle

Areas for immediate risk assessment

► Shift from the legal form to the economic reality of a transaction: where the economically relevant

characteristics of a transaction are inconsistent with contractual terms, the actual transactions

should in general be identified based on conduct of parties

► Contractual allocation of risk without sufficient control will not be regarded at arm’s length

Actions 8–10

Framework for the analysis of commodity transactions from a transfer pricing

perspective

► Clarifications on the application of the CUP method for commodity transactions

► Guidance regarding the pricing date

Guidance on commodity transactions

Guidance on the transactional profit split method (“PSM”)

► Confirms the use of the PSM as appropriate to align profits with value creation

► Outlines the revised scope of further work to be completed

► Draft guidance to be developed by WP6 in 2016 and finalized in 2017


► Expectation that quoted prices will increasingly be used to determine the transfer pricing for

commodity transactions

► Profit splits may be used to divide residual income after paying a cost plus remuneration to limited

function entities – using production capacity, headcount and value of production to split

Actions 8–10

Section A: Defining intangibles for TP purposes

► Intangible definition unchanged from 2014 Report – new definition for marketing intangibles

Section B: Ownership of intangibles and transactions involving DEMPE

► Mere legal ownership does not by itself confer any right to the return from its exploitation

► Economic return from IP and costs will be allocated to entities that perform and control the

DEMPE functions

► Functional management, as well as contractual assumption, of risk required to allocate

financial consequences of risk-bearing to an enterprise

Section C: Transactions involving the transfer of intangibles

Section D: Supplemental guidance on pricing intangibles transactions

► Guidance on how to determine arm’s-length conditions for intangibles transactions unchanged

► New definition of Hard to Value Intangibles (HTVIs)

► Allowance for tax administrations to use ex-post evidence for evaluating ex-ante pricing

arrangements

Guidance on intangibles

Actions 8–10

Guidance on intangibles


► DEMPE functions – who is entitled to any intangible related return?

► Legal ownership and funding the development of an intangible alone insufficient for full return

on intangibles exploitation

► Legal owners who outsource key DEMPE functions not entitled to (all) IP returns

► If DEMPE contributors are remunerated on a one-sided basis, reliability of transfer pricing

reduced

► Allows for a risk-adjusted rate of return to pure funders, but funder must manage the financial

risks

► Need to align IP with DEMPE functions

► More focus on substance, comparability and functionality and documentation (legal agreements)

Key risk areas for operating models involving IP

• Potential reporting and

transactional mapping errors

• Accounting, billing, reporting

processes may need adjusting

• ERP systems may need

reconfiguring

• Business processes and

KPIs may need

redefining and documenting

• Increased audit scrutiny

• Failure to comply with

substance requirements that

underpin tax rulings resulting in

reallocation of profits via

transfer pricing (TP)

adjustments between operating

model legal entities

• Lack of supporting

documentation – business

process manuals, TP

documentation, ways of

working, governance to support

TP methodology/profit

allocation

• Repayment of multiple years of

tax benefits if illegal EU State

Aid

• Failure to comply with local

country filing requirements

including PE/VAT

• Under declaration and payment

of income tax and/or VAT –

interest and penalties

• Reputational risk arising

from media coverage

The impact of BEPS on IP structures

Low

High

Tax risk

Low HighPost-BEPS profit attribution

Offshore IPCo

with limited

functions

Onshore IPCo

with limited

functions

Onshore IPCo with

commercial risk

management

functions

Offshore

“Cash box” IPCo

► Funding of IP

► Decisions made remotely

from IPCo

Plus

► Regular, substantive Board of

Directors meetings

► Potential IP or risk management

committee or branch operations

Plus

► Tax resident IP owner (e.g.,

entitled to amortization)

► Local management of

certain functions, such as

supply chain operations or

regional sales

Plus

► Management of all

relevant commercial

risks, including active

oversight of IP

development, protection

and exploitation

► Offshore IPCo refers to an entity that is located in a tax haven or otherwise not a tax resident.

In the Courts

Trends in transfer pricing cases

Significant Canadian disputes in the courts include:

► Cameco - $2.2 billion CRA reassessment

► Silver Wheaton - $600 million CRA reassessment

► Cameco

► CRA challenged the sale of uranium to a related party in

Switzerland, for a fixed 17 year term at $10 US a pound –

approximately the spot price at the time the contract was

signed

► The price spiked to approximately $130 a pound in 2007 and

trades at approximately $30 currently

► The CRA has challenged whether arm’s length parties would

have entered into this type of agreement and has put profits

back into Canada

Trends in transfer pricing cases

► Silver Wheaton (see more in the deck below)

► CRA challenged the use of related party special purpose

entities to enter into streaming contracts, contending that all the

value of the contracts was created in Canada and not in

Barbados and the Cayman Islands

► The CRA re-characterised the inter-company transactions and

placed the revenue streams from the various streaming

contacts back to the Canadian legal entity – resulting in an

approximate $600 million reassessment

► Also, shareholders of the company are understood to have filed

a class action lawsuit claiming that Silver Wheaton failed to

properly disclose information of the tax structure in its annual

financial report

► As part of the law suit, three senior executives are also

understood to have been named

Chevron Australia Holdings v Commissioner (2017) –Australian case


► Facts and issue

► CAHPL is indirectly wholly-owned by Chevron Corporation (CVX), a US-based oil and

gas company listed on the New York Stock Exchange. CAHPL effected an internal

refinancing, including to fund CAHPL's acquisition of Texaco Australia Pty Ltd, by

entering into a 'Credit Facility Agreement‘ between CAHPL and its US subsidiary

Chevron Texaco Funding Corporation (CFC), established for the sole purpose of raising

money through the issue of commercial paper in the US

► Under the Credit Facility Agreement, CFC on-lent these funds to CAHPL at an interest

rate of approximately 9% and CAHPL drew down, on two separate occasions, a total of

the Australian dollar equivalent of US$2.45 billion

► The Credit Facility Agreement was not consistent with the Chevron external financing

borrowing policy i.e. no security provided. In addition, there was no guarantee in

respect of the loan

► CAHPL claimed tax deductions in Australia for the interest it paid to CFC. The income it

received from CFC, by way of dividends, was treated as non-assessable non-exempt

income. Thus, CAHPL reduced its Australian taxable income through the deductions

claimed, whilst CFC made significant profits which were not taxed in either the US or

Australia.

► The issue whether the interest paid by CAHPL to CFC exceeded an arm’s length price

for the borrowing.

► Findings and implications

► On 21 April 2017 the Full Federal Court (Court) delivered its judgement.

► The Court concluded that, when considering the interest rate applicable to a borrowing

from a related company, it was reasonable to assume that, in a hypothetical arm’s

length scenario, the ultimate parent company would have provided a security and

covenants to the loan arrangement and the arm’s length interest rate should be

assessed on the basis of such a guarantee being in place, thus resulting in a lower

interest rate. Thus the borrower was not treated as a stand-alone/orphan company.

Chevron may apply for special leave to appeal to the High Court.


McKesson (2013) – Tax Court of Canada (seminal case)

► Facts

► MCC is the principal Canadian operating company and the indirect wholly owned

subsidiary of McKesson Corporation (McKesson US), the largest United States public

health care company. The McKesson corporate group specializes primarily in the

wholesale distribution of above-the-counter pharmaceutical and medical products

► The group accounted for roughly one-third of the US and Canadian pharmaceutical

distribution market shares during 2003. McKesson’s customers in the United States and

Canada include pharmacies, grocery and department store chains, hospitals, as well as

health and long-term care institutions

► The disputed factoring transaction was originally put in place on 16 December 2002,

when MCC sold all of its eligible third-party trade receivables (approximately $460

million) to MIH under a five-year intercompany factoring contractual arrangement

consisting of the Receivables Sales Agreement (RSA) and an accompanying Servicing

Agreement.

► Under the RSA, MCC sold eligible trade receivables to MIH daily at a specified discount

from the receivables’ face value

► Under the Servicing Agreement, MCC was retained as a service provider to MIH and

was responsible for performing day-to-day monitoring, collection and recording

activities associated with the factored receivables


► Facts

► The total face value of outstanding factored accounts receivable remained above the

minimum initial contractual limit of $460 million during FY2003

► The RSA included a provision whereby MIH had the right to return the unpaid “bad”

receivables to MCC at a 25% discount, which would later be adjusted downward to the

amount actually collected by MCC

► This provision effectively shifted the liquidity risk of non-performing receivables from

MIH back to MCC, but did not protect MIH from default risks on non-performing

► receivables

► The RSA also gave MIH early termination rights which it could exercise in specified

circumstances, including the actual or anticipated material deterioration in the credit-risk

quality of MCC and the factored receivables

► MIH borrowed all funds from one of its Irish indirect parent entities to finance its

purchases of factored receivables. This loan was fully guaranteed by another

Luxembourg indirect parent entity


► Facts and Issue

► During FY2003, MCC sold its receivables at the 2.206% contractual discount from the

receivables’ face value, which amounted to an annualized effective rate of roughly 27%,

given the receivables’ average of approximately 30 days outstanding

► The discount rate under the RSA was calculated as the sum of three components, a

Yield Rate, a Loss Discount and a Discount Spread

► The Yield Rate, intended to reflect a baseline risk-free borrowing rate, was set equal to

the 30-day CDOR interest rate

► The Loss Discount, intended to reflect the risk of non-payment by obligors, was fixed in

the RSA at the weighted average rate of 0.23% for FY2003, subject to an annual

recalculation, although MIH had the option to request recalculation on a monthly basis

► In its transfer pricing audit of MCC’s FY2003 factoring transactions, the CRA challenged

that the discount rate on the receivables sold by MCC to MIH was greater than the rate

that would be provided to MIH in an arm’s-length factoring transaction


► Finding

► For the Yield Rate, the Court accepted that the annual CDOR rate, adjusted to reflect

the much shorter period over which receivables would be collected (referred to as Days

Sales Outstanding, or DSO), was appropriate. However, the Court concluded that DSO

should be floating, recomputed every three or four months, rather than fixed at 31.73

days for the entirety of the RSA

► The Court also concluded that DSO for the original $460 million of receivables

purchased on 16 December 2002 should not have been averaged over the entire five-

year term of the RSA. The Court concluded that the appropriate DSO was 30 days

throughout FY2003 (based on a four-month rolling average).


► Implications

► In interpreting Section 247 of the Act, the Court reiterated the importance of performing

adjustments to account for material differences between intercompany contractual

terms and conditions and the terms and conditions that arm’s-length parties would

normally agree to.

► Under paragraphs 247(2)(a) and (c), the Court is not limited to adjusting amounts, but

can revise the terms and conditions to conform to what arm’s-length parties would have

agreed to.

► The Court specifically commented that there was no compelling reason to depart from

the Supreme Court of Canada’s approach and comments in seminal Canadian case

GlaxoSmithKline: “arm’s-length persons should generally be assumed for purposes of

section 247 to act neither irrationally nor unreasonably” and “should be expected to

transact for products and services at amounts within the range of their fair market value

having regards to all relevant circumstances.”


General Electric Capital (2009) – Tax Court of Canada (seminal case)

► Facts

► During the years under appeal, General Electric Capital Canada Inc. (GE Capital, or,

taxpayer) was a financial services company that carried on a number of businesses in

Canada, including equipment, vehicle and real estate financing and technology

management services

► GE Capital was a wholly-owned, indirect subsidiary of General Electric Capital

Corporation (GECUS), a US corporation

► The taxpayer financed its operations by borrowing funds from capital markets through

the issue of debt in the form of commercial paper and unsecured debentures

► GECUS began guaranteeing the taxpayer's debt in 1988, but only started charging

guarantee fees calculated at a rate of 1% per annum of the principal amount of debt

outstanding, in 1995


► Finding

► The Court allowed the taxpayer's appeal and vacated all of the Minister's assessments.

The Court rejected the taxpayer's argument that the taxpayer's credit rating had to be

determined on a stand-alone basis

► In reaching this conclusion, the Court considered relevant authorities on the meaning of

arm's length and concluded that the concept refers to "how independent parties

negotiating with each other in the marketplace would behave for the purpose of

achieving the best terms" in respect of the purchase or sale of goods and services

(para. 196). In this context, the "implicit support" of the parent company could not be

ignored

► In determining the arm's-length price, the Court considered significant expert advice.

These experts articulated that there were three alternative models that could be utilized

to determine the arm's-length guarantee fee that would apply to the tested transactions,

namely (i) the yield approach, (ii) the insurance approach and (iii) the credit default

swap approach


► Finding (cont’d)

► The Court accepted that the "yield" approach put forward by the Crown to assess the

guarantee's value was the most appropriate; however, it determined that the proper

application of this approach, in consideration of the facts and circumstances of this

case, favoured the taxpayer

► The Court concluded that the taxpayer's final credit rating without explicit support would

be in the range of BBB-/BB+, significantly below AAA (the rating achieved with the

guarantee in place), and one to two notches higher than the stand-alone credit rating

(BB) excluding implicit support from GECUS. The interest cost savings to the taxpayer

based on the differential between BBB-/BB+ and AAA was determined to be

approximately 1.83% (based on one of the expert reports). Therefore, the 1%

guarantee fee was found to be below an arm's length price in the circumstances.


► Implications

► The "GE case“ has far reaching implications for multinational companies operating in

Canada

► The decision in this case arguably challenges the Organisation for Economic Co-

operation and Development's (OECD's) interpretation of the arm's-length principle. The

decision may impact many aspects of the transfer pricing practice in Canada and

beyond the narrow subject matter of financial guarantees between related entities, such

as:

► Changes to OECD definition of "arm's length"

► Endorsement of yield approach for financial guarantee fees

► Endorsement of "halo" effect for financial guarantee fees

► Identifying the existence of implicit support is only the first step. The second

step is to determine how much that implicit support is worth. In the present

case, the judge decided that a third-party insurer would not attach much value

to implicit support of a parent company.

► Facts and circumstances are paramount


Silver Wheaton Corporation and HMTQ, Court File No. 2016-77(IT)G – case yet to be determined


► Understanding of Facts

► ("Silver Wheaton Canada") has foreign subsidiaries that enter into long-term contracts

to purchase precious metal (in particular, silver and gold) in respect of mines located

outside of Canada. Those foreign subsidiaries earned profits from the sale of precious

metal acquired under such contracts. In reassessments under the Income Tax Act, RSC

1985 c. 1 (5th Supp.), (the "Act"), the Minister of National Revenue (the "Minister") has

effectively:

► (a) disregarded the existence of the foreign subsidiaries,

► (b) taxed the profits of the foreign subsidiaries as though they were taxable income

of Silver Wheaton Canada, and

► (c) levied associated transfer pricing penalties.

► Issue

► The issue in this appeal is whether the reassessments are correct

► Taxpayer’s position

► In the Reassessments, the Minister, relying on paragraph 247(2)(d) or alternatively

paragraph 247(2)(c) of the Act, attributed to Silver Wheaton Canada substantially all of

the profits earned by Silver Wheaton Cayman and Silver Wheaton Luxembourg from

the sale of precious metal they acquired under their Precious Metal Purchase

Agreements M respect of foreign mines

► The object of subsection 247(2) is to require arm's length pricing for any transaction or

series of transactions in which a taxpayer and a non-resident person with whom the

taxpayer does not deal at arm's length are participants

► The only transactions relevant to this appeal in which Silver Wheaton Canada and a

non-arm's length non-resident were participants were the provision of services by Silver

Wheaton Canada to Silver Wheaton Cayman for fees

► The Minister's primary basis for those income inclusions is paragraph 247(2)(d), which

applies when the conditions of paragraph 247(2)(b) are met

► Those conditions are met if a transaction or series of transactions in which a taxpayer

and a non-arm's length non-resident are participants


► CRA’s position

► The Transactions would not have been entered into by arm's length parties

► The Transactions can reasonably be considered not to have been entered into primarily

for bona fide purposes other than to obtain a tax benefit, namely the reduction of

Canadian income tax, which was achieved by having SW Caymans instead of SW

Canada enter into the precious metal purchase agreements (“PMPAs”) in respect of

mines located outside of Canada so that income from the sale of Precious Metal would

be reported outside of Canada


DSG Retail Ltd v HMRC (2009) – U.K. case

► Undertsanding of Facts

► Dixons offered its customers, at point of sale, the opportunity to purchase extended

warranty for replacement repair beyond the normal manufacturer’s warranty

► Following the take-over of Currys by Dixons, the DSG group entered into an

arrangement with Cornhill, a third-party insurer, whereby in-store personnel would

arrange warranty insurance policies for customers with Cornhill

► Cornhill entered into a separate administration and repair contract arrangement with

another DSG company

► Cornhill reinsured 95% of the risk with another DSG company, DISL (a wholly owned

group company resident in the Isle of Man) and, accordingly, 95% of Cornhill’s premium

income was ceded to DISL

► Subsequently, the rate of applicable insurance premium tax (IPT) increased, and in

response, the DSG Group came up with non-insurance-based contracts would be

entered into instead of policies with consumers.

► ASL, an Isle of Man intermediary, subsequently became a third-party insurance broker

► ASL entered into an administration and repair arrangement with a DSG group company

and reinsured 100% of its risk with DISL


► Issue

► According to the HMRC, a benefit had been conferred upon DISL that would not have

occurred had the parties been operating on an arm’s-length basis

► The HMRC argued that the insurance/service warranty contracts between customers

and independent third parties only occurred given the back-to-back arrangements with

DISL. In this manner Cornhill, and the Isle of Mann intermediary, ASL, were mere

conduits


► Finding

► Even if no evidence about the level of risk to which DISL was exposed was agreed

upon, the Special Commissioners found that DISL was extremely profitable

► HMRC’s expert stated that where competition exists, eventually it will force higher

returns down to a ‘normal’ market level; however, if economic profits of this nature arise

due to a lack of competition, these will be distributed between the parties according to

the ability of each party to protect itself from normal competitive forces.

► The Special Commissioners found that DSG bore ‘almost all the long-term bargaining

power’

► The point of sale advantage particularly gave DSG this ability, given DSG was the

largest electrical goods retailer in the UK, in addition to the low cost of switching

insurers, its access to data on past claims, and the fact that it possessed no need for

an external brand to support its warranties

► In contrast, DISL was entirely dependent on the DSG group for its business. Overall,

the Special Commissioners considered DISL possessing merely routine know-how,

which DSG was able to procure for itself

► As such, DISL was entitled only to routine market return on economic capital

► All CUPS DSG put forward to support the commission received were rejected for

market conditions and product characteristics


► Finding (cont’d)

► Furthermore, having rejected the CUP method, the Special Commissioners held that

the appropriate method was the profit split, and that this should be based upon the

capital asset pricing model used for calculating a return on capital

► The appropriate profit split would give the insurance company a return on its capital, but

give the majority of the profit to the retailer for its intangibles

► Implications

► Increased scrutiny of financial services transactions

► Negotiating power may need to be be considered

► From an economic analysis perspective, there is high threshold of comparability

required when CUPs are relied upon, especially if the profits cannot immediately be

explained

► Where complex transactions appear to obscure the underlying economic reality, the

profit split method approach would be appropriate

► Specific facts and circumstances need to be considered


Discussion and Questions?

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