Transfer Pricing in Canada: The Arm's-Length Principle and the New

(1997), Vol. 45, No. 6 / no 6 1213

Transfer Pricing in Canada:The Arm’s-Length Principleand the New Rules

François Vincent and Ian M. Freedman*

PRÉCISRécemment, les autorités fiscales canadiennes ont publié de nouvellespropositions sur la réglementation des prix de transfert constituéesd’amendements à la législation fiscale existante et d’un projet decirculaire d’information, l’objectif étant « d’harmoniser » les règles deprix de transfert canadiennes avec le principe de pleine concurrenceénoncé par l’OCDE.

Dans cet article, les auteurs font une brève révision des règlesproposées et tentent d’établir si le Canada a atteint son objectifd’harmonisation. L’article discute aussi des fondements juridiques et dela force exécutoire des règles contenues dans le projet de circulaired’information.

Quant à l’harmonisation, les auteurs ont conclu que les nouvellesrègles ont, de façon générale, atteint l’objectif que s’était fixé le Canadapour son régime de réglementation de prix de transfert . Ils identifienttrois différences principales dans les libellés respectifs du principe depleine concurrence au Canada et à l’OCDE pour conclure qu’elles sontprincipalement de forme et non de fond. Cependant, ils font remarquerune exception importante à ce principe général : le libellé de l’OCDE surle principe de pleine concurrence semble se prêter beaucoup plusfacilement aux analyses de fin d’année que ne le permet l’approchecanadienne.

Pour ce qui a trait à l’utilisation d’un projet de circulaire d’informationpour mettre en place des règles quasi-législatives, les auteurs concluentque ces règles n’ont pas de force exécutoire. Plus particulièrement, ilsprécisent qu’à leur avis, les cours de justice auraient une latitudeconsidérable pour accepter des méthodes non traditionnellesd’établissement des prix de transfert , voire même des méthodes ditesinférieures dans la hiérarchie des méthodes acceptées (par exemple, la

* François Vincent is of Stikeman Elliott, Montreal and Ian M. Freedman is of StikemanElliott, Toronto. The authors would like to thank Dr. Lorraine Eden and Robert Hogan fortheir assistance and comments in the preparation of this article. All errors and omissionsare, of course, the authors’ responsibility.

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méthode transactionnelle de la marge nette) que celles proposées dansle projet de circulaire d’information. Le choix de la méthode appropriéed’établissement des prix de transfert est crucial, tant pour l’évaluationdes politiques de prix de transfert d’une entreprise que pour déterminersi un contribuable a fait des « efforts sérieux » dans l’établissement deces prix de transfert . Si de tels efforts sérieux n’ont pas été faits ou sontprésumés ne pas avoir été faits, un contribuable pourrait faire face à unrégime onéreux de pénalités si un redressement de ces prix de transfertdevait être effectué par Revenu Canada.

ABSTRACTThe Canadian tax authorities recently released proposed new transfer-pricing rules. These new rules are set out in draft legislation andexpanded upon in a draft information circular. The aim of the new rulesis to “harmonize” Canada’s transfer-pricing practices with the arm’s-length principle outlined by the OECD in its recently revised transfer-pricing guidelines.

In this article, the authors briefly review the proposed new rules andconsider whether or not they achieve their stated objective. In addition,the authors consider the legal basis for, and the enforceability of,numerous “quasi-rules” set out in the draft information circular.

On the first point , the authors conclude that the new rules have, inmany respects, achieved their objective of harmonizing Canada’stransfer-pricing regime with that of the OECD. The authors consider threeprincipal differences in phraseology between the Canadian and the OECDdescription of the arm’s-length principle. They conclude that, for themost part, these differences in phraseology do not result in significantdifferences of substance. However, there is one important exception:the language used by the OECD seems to leave more room for year-endor aggregative analyses of transfer prices than does the wording of theproposed legislation.

As regards the use of the draft information circular to promulgate“quasi-rules,” the authors note that such “quasi-rules” are not legallyenforceable. In particular, the courts might have more latitude to acceptnon-traditional and low-ranked transfer-pricing methodologies (such asthe transactional net margin method) than is suggested in the draftinformation circular. The choice of transfer-pricing methodology isrelevant both with respect to the evaluation of a taxpayer’s transfer-pricing practices and with respect to the determination of whether“reasonable efforts” were made by a taxpayer to establish arm’s-lengthtransfer prices. In the absence of such “reasonable efforts,” a taxpayermay be subject to significant penalties in the event that a transfer-pricing adjustment is made by Revenue Canada.

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INTRODUCTIONIn the supplementary information package tabled with the federal budgetof February 18, 1997,1 the government formally announced that it wouldbe making changes to Canada’s transfer-pricing regime. The stated objec-tive of these changes was to “harmonize” Canada’s transfer-pricingpractices with the arm’s-length principle outlined by the Organisation forEconomic Co-operation and Development (OECD) in its recently revisedtransfer-pricing guidelines.2

On September 11, 1997, as had been foreshadowed in the budget, theCanadian tax authorities released draft amendments to the Income TaxAct3 (“the proposed legislation”) as well as a draft revision of Informa-tion Circular 87-2.4 The proposed legislation has since been revised inresponse to comments received from the tax community and has been re-released as a component of the December 8, 1997 notice of ways andmeans motion (“the NWMM”). A revised version of the draft circular, alsoamended in response to comments received from the tax community, isexpected to be released sometime in 1998 but had not yet been released atthe time of the writing of this article.

In this article, we consider whether the new transfer-pricing rules setout in the proposed legislation and the draft circular (“the new rules”)achieve their stated objective of harmonizing Canada’s transfer-pricingpractices with the arm’s-length principle described by the OECD. In addi-tion, we consider the legal basis for, and the enforceability of, the numerous“quasi-rules” set out not in the proposed legislation, but instead in thedraft circular.

CANADA’S EXISTING TRANSFER-PRICING REGIME:LEGISLATION AND PRACTICEProvisions dealing specifically with transfer pricing have existed in Cana-da’s income tax legislation since 1938.5 The provisions in place at thetime of the budget were subsections 69(2) and (3) of the Act. The test set

1 Canada, Department of Finance, 1997 Budget, Budget Plan, February 18, 1997 (hereinreferred to as “the budget”).

2 Organisation for Economic Co-operation and Development, Transfer Pricing Guide-lines for Multinational Enterprises and Tax Administrations (Paris: OECD) (looseleaf )(herein referred to as “the OECD guidelines”).

3 RSC 1985, c. 1 (5th Supp.), as amended (herein referred to as “the Act”). Unlessotherwise stated, statutory references in this article are to the Act.

4 Draft Information Circular 87-2R, September 11, 1997 (herein referred to as “thedraft circular”).

5 This article is not intended to present an extensive review of Canada’s prior transfer-pricing legislation and practices. For background of this kind, see François Vincent,“Transfer Pricing in Canada: An Overview” (1996), vol. 5, no. 15 Tax Management Trans-fer Pricing Special Report, report no. 25; Carl F. Steiss and Luc Blanchette, “TheInternational Transfer-Pricing Debate” (1995), vol. 43, no. 5 Canadian Tax Journal 1566-1602; and Nathan Boidman, “Transfer Pricing in Canada,” in The Tax Treatment of TransferPricing (Amsterdam: International Bureau of Fiscal Documentation) (looseleaf ).


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out in those provisions for evaluating cross-border transfer prices waswhether the amount paid or payable between a taxpayer and a non-residentperson with whom the taxpayer was not dealing at arm’s length “wouldhave been reasonable in the circumstances if the non-resident person andthe taxpayer had been dealing at arm’s length.” Hence, it was a notion ofreasonableness, evaluated in comparison with amounts paid between par-ties dealing at arm’s length, which formed the legislative basis for theapplication of the arm’s-length principle. Subsections 69(2) and (3) weresupplemented by Information Circular 87-2, which formally endorsed thearm’s-length principle set out in the 1979 OECD report on transfer pric-ing.6 This administrative position and the related legislative provisionswere never seriously challenged; jurisprudence was all but non-existentwith regard to subsections 69(2) and (3);7 and until relatively recently, in-depth audit of transfer prices was the exception rather than the rule.However, as industry-wide audits in the late 1970s and early 1980s of thepharmaceutical, forestry, and oil and gas industries provided the Cana-dian tax authorities with what they considered to be strong indications ofabuse in transfer pricing by multinationals doing business in Canada, thegovernment gave Revenue Canada a clear mandate (as well as the neces-sary funding) to tackle this issue. Since then, we have seen an increasingnumber of transfer-pricing audits8 and a growing body of commentary onthe Canadian position with regard to transfer pricing.9 It is only in recent

6 Organisation for Economic Co-operation and Development, Transfer Pricing and Mul-tinational Enterprises (Paris: OECD, 1979) (herein referred to as “the 1979 OECD report”).

7 Although there have been a few transfer-pricing situations that have found their wayto court, there is only one case that actually dealt with subsection 69(2), Indalex Ltd. v.The Queen, [1986] 1 CTC 219 (FCTD), aff ’d. [1988] 1 CTC 60 (FCA). Even Indalex wasperhaps decided more as a tax-avoidance case than as a transfer-pricing case: see Vincent,supra footnote 5, at 7-12. There is a tax evasion case that mentions subsection 69(3) inpassing, but it fails to provide any meaningful analysis of that provision: The Queen v.Kleysen, [1996] 2 CTC 201 (Man. QB). In Cudd Pressure Control Inc. v. The Queen,[1995] 2 CTC 2382 (TCC) (notice of appeal has been filed in the Federal Court of Ap-peal), the judgment refers explicitly to the 1979 OECD report although the dispute is notbased on subsection 69(2) or (3) of the Act.

8 As illustrated by the comments of Martin Przysuski, senior international tax auditorspecialist for Revenue Canada in Toronto, “How To Prepare for an International Audit,” inInnovative Transfer Pricing Strategies: Practical Solutions for Effective Risk Management(Toronto: Insight Press, 1997), article IX. Przysuski stated that it is only a question of timebefore every multinational in Canada will have its transfer-pricing practices audited. It isalso worth noting the comments made by the auditor general in his November 1996 reportto the effect that there have not been as many referrals of transfer-pricing issues to inter-national auditors from the large file program as would have been expected: see Canada,Report of the Auditor General of Canada to the House of Commons (Ottawa: Public Worksand Government Services, 1996), paragraphs 37.32 to 37.36. However, the report doesnote that it expects to see an increase in transfer-pricing audits in the large file program.

9 As evidenced by the many conferences dealing with transfer pricing that have beentaking place since the early 1990s, particularly in the Toronto area, and the numerouspapers produced by participants at such conferences.


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years that appeals have been filed in respect of transfer-pricing assess-ments10—although, unless settlements are reached, the final determinationof these cases by the courts is likely still years away.

Much of the Canadian focus on transfer pricing has been and continuesto be precipitated by the actions of the US tax authorities in this field andby the powerful international reaction that those actions have triggered.11

The United States’ well-publicized introduction of documentation require-ments and penalties relating to transfer pricing was simply too fundamentalto ignore, and the Canadian tax authorities were concerned that the Cana-dian tax base would be eroded by a shift of profits toward Canada’s majortrading partner through the use of transfer prices.

It is with this background in mind that the Canadian tax authoritiesstarted to re-evaluate the effectiveness of subsections 69(2) and (3) and toconsider the need to bring Canada’s transfer-pricing rules into closer con-formity with the arm’s-length principle, which Canada had vigorouslydefended during the negotiations leading up to the OECD guidelines.

SYNOPSIS OF THE NEW RULESThe proposed legislation will, inter alia, repeal subsections 69(2) and (3)and replace them with proposed section 247. The charging provision ofproposed section 247 is subsection 247(2), which provides, in essence,that Revenue Canada must adjust the quantum or nature of any amount inrespect of a transaction between a taxpayer12 and a non-resident personwith whom the taxpayer does not deal at arm’s length where either theterms or conditions made or imposed in respect of the transaction differfrom those that would have been made between persons dealing at arm’slength, or the transaction itself would not have been entered into betweenpersons dealing at arm’s length and it can reasonably be considered thatthe transaction was not entered into primarily for bona fide purposesother than to obtain a tax benefit.13 The amounts in question are to be

10 See Roger Taylor, “Current Tax-Avoidance Cases,” in Report of Proceedings of theForty-Seventh Tax Conference, 1995 Conference Report (Toronto: Canadian Tax Founda-tion, 1996), 12:1-15, at 12:15.

11 See Organisation for Economic Co-operation and Development, Tax Aspects of TransferPricing Within Multinational Enterprises: The United States Proposed Regulations (Paris:OECD, 1993).

12 For the sake of brevity, the word “taxpayer” will be used in this article as encom-passing both a taxpayer and a partnership unless the context requires otherwise.

13 Proposed subsection 247(2) reads as follows:

Where a taxpayer or a partnership and a non-resident person with whom the tax-payer or the partnership, or a member of the partnership, does not deal at arm’slength (or a partnership of which the non-resident person is a member) are partici-pants in a transaction or a series of transactions and

(a) the terms or conditions made or imposed, in respect of the transaction orseries, between any of the participants in the transaction or series differ from thosethat would have been made between persons dealing at arm’s length, or

(The footnote is continued on the next page.)


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adjusted by Revenue Canada to reflect the amounts that would have re-sulted had the terms, conditions, and nature of the transaction beendetermined by arm’s-length parties.

Proposed subsections 247(3) and (4) are designed to buttress the charg-ing provisions of proposed subsection 247(2) and to address RevenueCanada’s concerns about the existence and availability of informationpertaining to the transfer-pricing practices of multinational enterprises.Proposed subsection 247(3) establishes a mechanism by which a taxpayersubject to a transfer-pricing adjustment, whether on account of income orof capital, will, subject to a minimum threshold and a limited right of “set-off,” automatically be liable to pay a penalty unless such adjustment canreasonably be considered to relate to a qualifying cost contribution arrange-ment or unless the taxpayer made reasonable efforts to determine arm’s-length transfer prices.14 Proposed subsection 247(1) defines “qualifying

(b) the transaction or series

(i) would not have been entered into between persons dealing at arm’slength, and

(ii) can reasonably be considered not to have been entered into primarilyfor bona fide purposes other than to obtain a tax benefit,

any amounts that, but for this section and section 245, would be determined for thepurposes of this Act in respect of the taxpayer or the partnership for a taxation yearor fiscal period shall be adjusted (in this section referred to as an “adjustment”) tothe quantum or nature of the amounts that would have been determined if,

(c) where only paragraph (a) applies, the terms and conditions made or imposed,in respect of the transaction or series, between the participants in the transaction orseries had been those that would have been made between persons dealing at arm’slength, or

(d) where paragraph (b) applies, the transaction or series entered into betweenthe participants had been the transaction or series that would have been entered intobetween persons dealing at arm’s length, under terms and conditions that wouldhave been made between persons dealing at arm’s length.14 Proposed subsection 247(3) includes a threshold by virtue of which the penalty will

apply only where the total of the transfer-pricing capital adjustments and the transfer-pricingincome adjustments (excluding those relating to qualifying cost contribution arrangementsand those for which reasonable efforts were made in the determination of the transfer pricesor arm’s-length allocations, and subject to the limited right of setoff mentioned below)exceeds the lesser of 10 percent of the taxpayer’s gross revenue (defined in subsection248(1) of the Act) for the year (if the Act were read without reference to proposed subsec-tion 247(2), subsections 69(1) and (1.2), and section 245), and $5 million. In this respect,there is an anti-avoidance provision in proposed subsection 247(9) whereby a transaction ora series of transactions shall be deemed not to have occurred for the purposes of determiningthe threshold described above if one of the purposes of the transaction or series of transac-tions was to increase the taxpayer’s gross revenue. In response to significant adverse reactionin the tax community concerning the absence of any ability to set off beneficial adjustmentsagainst detrimental adjustments in determining the base upon which penalties are calculated,the NWMM has permitted an extremely limited right of setoff. This issue is discussed ingreater detail in François Vincent and Ian Freedman, “Canadian Transfer Pricing: FinanceMakes Changes but Cedes Little Ground” (January 5, 1998), 16 Tax Notes International 8-11.

13 Continued . . .


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cost contribution arrangement”15 as an arrangement under which reason-able efforts have been made by the participants in establishing a basis forthe allocation of the costs of producing, developing, or acquiring anyproperty, or of acquiring or performing any services, in proportion to thebenefits that may reasonably be expected to be derived by each partici-pant as a result of the arrangement. It is interesting to note that despitethe deliberate absence of the notion of reasonableness in proposed sub-section 247(2), which notion was present in subsections 69(2) and (3) andwas often criticized as being too subjective and elusive, the notion ofreasonableness nonetheless surfaces as being a pivotal part of the applica-tion of the penalty through the use of the expression “reasonable efforts”16

in the proposed exception from the penalty pursuant to clause 247(3)(a)(ii)(B)and the use of the same expression in the definition of qualifying costcontribution arrangements, which arrangements are excluded from thepenalty provision pursuant to proposed clause 247(3)(a)(ii)(A).

The notion of “reasonable efforts” is not defined in the Act. However,proposed subsection 247(4) introduces a deeming rule by which a taxpayerwill be deemed not to have made reasonable efforts in respect of a transac-tion unless the taxpayer makes or obtains, on or before the taxpayer’s“documentation due date”17 for the taxation year or fiscal period in whichthe transaction occurs, records or documents that provide a complete andaccurate description in all material respects of six listed elements18 and of

15 Other expressions defined in proposed subsection 247(1) for the purposes of pro-posed section 247 include “arm’s length allocation,” “arm’s length transfer price,”“transaction,” “transfer price,” “transfer pricing capital adjustment,” and “transfer pricingincome adjustment.” The expression “series of transactions” is defined in subsection 248(10).

16 For a discussion of the wide-ranging interpretation of reasonableness in the contextof subsections 69(2) and (3), see Vincent, supra footnote 5, at 4-5.

17 The term “documentation due date” is defined in proposed subsection 247(1) as “(a)in the case of a person, the person’s filing due date for the year; or (b) in the case of apartnership, the day on or before which a return is required by section 229 of the IncomeTax Regulations to be filed in respect of the period or would be required to be filed if thatsection applied to the partnership.”

18 The six listed elements in proposed paragraph 247(4)(a) are(i) the property or services to which the transaction relates,

(ii) the terms and conditions of the transaction and their relationship, if any, tothe terms and conditions of each other transaction entered into between the partici-pants in the transaction,

(iii) the identity of the participants in the transaction and their relationship toeach other at the time the transaction was entered into,

(iv) the functions performed, the property used or contributed and risks assumed,in respect of the transaction, by the participants in the transaction,

(v) the data and methods considered and the analysis performed to determinethe transfer prices or the allocations of profits or losses or contributions to costs, asthe case may be, in respect of the transaction, and

(vi) the assumptions, strategies and policies, if any, that influenced the determi-nation of the transfer prices or the allocations of profits or losses or contributions tocosts, as the case may be, in respect of the transaction.


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any material changes to these elements in subsequent taxation years orfiscal periods in which the transaction continues, and provides these recordsor documents to the minister of national revenue within three months afterservice of a written request therefor. Thus, failure to abide by any of theserequirements will result in the taxpayer’s being deemed not to have madereasonable efforts and will subject the taxpayer to the penalty providedunder proposed subsection 247(3) in the event that any transfer-pricingadjustments occur.19 In this respect, it is important to stress that whileproposed subsection 247(4) deems a taxpayer who has not complied withthe conditions specified therein to have not made “reasonable efforts,” theconverse is not true. Instead, this one-way deeming rule reserves discre-tion for the minister to argue that a taxpayer has not made reasonableefforts and to subject the taxpayer to a penalty, even in cases where all therequired contemporaneous documentation has been prepared and providedto the minister within the applicable time limits.

While the new rules provide no clear “safe harbour” whereby, if cer-tain identifiable conditions are satisfied, a taxpayer will be deemed tohave made “reasonable efforts,” the draft circular does contain some sug-gestions as to the approach that Revenue Canada might take in interpretingthe “reasonable efforts” concept. In this respect, paragraph 79 of the draftcircular provides, “In general, the Department considers that the makingof reasonable efforts requires the application of a recommended methodby the taxpayer [emphasis added].” The recommended methods from whichthe taxpayer may choose are the comparable uncontrolled price (CUP)method, the resale price method, the cost plus method, the profit-splitmethod, and the transactional net margin method (TNMM), although pref-erence is given to the first three. Thus, multinational enterprises makinguse of the comparable profits method (CPM), which is one the methodsaccepted in the United States, may find that unless their CPM is also anacceptable TNMM, Revenue Canada will consider that no reasonable ef-forts have been made and that a penalty therefore applies in the event thata transfer-pricing adjustment is made. The emphasis on the use of a rec-ommended method before “reasonable efforts” can be said to have beenmade, while expressly stated in the draft circular, is not specifically re-ferred to in the proposed legislation. We consider the impact of such“legislation by information circular” later in this article.

As well as noting the importance of using a recommended method ifreasonable efforts are to be found to have been made, the draft circularstates that in determining the scope of the documentation that must bemaintained under proposed subsection 247(4), a prudent business person’s

19 This penalty is subject, of course, to the threshold and the limited setoff right re-ferred to in footnote 14, supra. It should be mentioned that, pursuant to proposed subsection247(10), adjustments that are beneficial to the taxpayer can be made only at the discretionof the minister of national revenue where “circumstances are such that it would be appro-priate that such an adjustment be made.”


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standard should be employed. Specifically, the draft circular refers in thisrespect to “principles of prudent business management.”20

Revenue Canada did not invent the expression “principles of prudentbusiness management.” It is taken from chapter 5 of the OECD guidelines,where the requirement to maintain documentation is tied to “prudent busi-ness management principles.”21 In this respect, the OECD cautions that

the taxpayer should be expected to have prepared or obtained such docu-ments only if they are indispensable for a reasonable assessment of whetherthe transfer pricing satisfies the arm’s length principle and can be obtainedor prepared by a taxpayer without a disproportionately high cost beingincurred [emphasis added].22

This is one of the areas where the Canadian approach to transfer pricingdeparts somewhat from the OECD guidelines. Canada’s creation of a man-datory assembly of documents in respect of the six items referred topreviously does not appear to fully conform to the OECD’s wording andapplication of “prudent business management principles.” That is not tosay that the Canadian version of the arm’s-length principle does not con-form with the OECD version (this issue will be discussed subsequently inthis article), but it means that in its commitment to follow the OECDguidelines,23 Canada does falter in some respects. At least on the penaltyand documentation reporting side, Canada’s approach seems more in linewith that of the United States than with the OECD approach.

The draft circular elaborates on the meaning of the phrase “principlesof prudent business management” in paragraph 80 as follows:

A prudent businessperson would attempt to weigh the significance of thetransactions in terms of its business with the additional administrative costsrequired to prepare or obtain such documentation. Therefore, the obligationto find comparable transactions for purposes of applying the arm’s lengthprinciple is not an absolute one, but may take into account the cost andlikelihood of finding such comparable relative to the significance of thetransactions to the taxpayer.

This statement is in striking contrast to Revenue Canada’s criticism of theuse of the CPM in the United States. One of Revenue Canada’s complaintsabout the CPM was that multinational enterprises turned too quickly tothe use of this “method of last resort” because of its perceived cost-effectiveness, on the basis that the data needed for its application weremore readily available than those needed for other methods. While theprudent business management test suggested by Revenue Canada was prob-ably not intended as a justification of the CPM, it may nonetheless openthe door to other methods such as the TNMM and the residual profit-split

20 See draft circular, supra footnote 4, at paragraph 80.21 See OECD guidelines, supra footnote 2, at paragraph 5.4.22 Ibid., at paragraph 5.7.23 See draft circular, supra footnote 4, at paragraph 6.


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method24 if it is felt that these would be more practical and convenientfrom a business management standpoint.

THE NEW RULES: ADHERENCE TO THE ARM’S-LENGTHPRINCIPLERationale for the Arm’s-Length Principle25

Within a multinational enterprise, the conditions set in respect of transac-tions between affiliates may differ from those set between parties dealingat arm’s length for a multitude of reasons. Such reasons may include theintent to shift income from one jurisdiction to another (whether the shiftoccurs in favour of the parent company or toward an affiliate situated in amore favourable tax jurisdiction), the intent to minimize costs throughvertical integration and economies of scale, and the decision to penetratea given market in a given fashion. On the other hand, tax administrationsare generally concerned that the conditions set between the affiliates mayresult in an erosion of their respective tax bases. Accordingly, tax admin-istrations generally look for ways of ensuring that a fair share of incomein respect of any transaction or series of transactions is properly reportedand is liable to tax in their sphere of authority. As a result, different taxauthorities may adopt conflicting views in respect of given transactions orseries of transactions, and multinationals may consequently be subject todouble taxation.

To deal with this problem, the OECD proposed, in article 9 of the ModelTax Convention on Income and on Capital,26 the use of the arm’s-lengthprinciple. This principle was adopted by OECD members because theybelieved it represented the only acceptable way of dealing with the properallocation of profits between tax jurisdictions and of battling the perceivedavoidance of tax through the setting of unreasonable transfer prices andthe use of affiliates in tax havens.27 Although other allocation methods

24 See ibid., at paragraph 40.25 For an overview of the principles underpinning the international tax transfer-pricing

regime, see Lorraine Eden, Taxing Multinationals: Transfer Pricing and Corporate Taxa-tion in North America (Toronto: University of Toronto Press, 1998), 103-12.

26 Organisation for Economic Co-operation and Development, Model Tax Conventionon Income and on Capital (Paris: OECD) (looseleaf ) (herein referred to as “the OECDmodel tax convention”).

27 Although the OECD recognized in its 1979 report that transfer pricing should not beconfused with tax fraud or tax avoidance (see the 1979 OECD report, supra footnote 6, at9), transfer-pricing situations in Canada have given rise more often to court challengesbased on concepts or provisions of the Act dealing with anti-avoidance than to challengesbased on transfer-pricing provisions and principles. See, for instance, Spur Oil Ltd. v. TheQueen, [1980] CTC 170 (FCTD), rev’d. in part [1981] CTC 336 (FCA); and Irving OilLtd. v. The Queen, [1988] 1 CTC 263 (FCTD), aff ’d. [1991] 1 CTC 350 (FCA). It shouldalso be mentioned that section 482 of the US Internal Revenue Code of 1986, as amended(herein referred to as “IRC”), specifically refers to the evasion of taxes and the clearreflection of income as reasons for transfer-pricing adjustments to be made.


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have been considered by the OECD, such as global formulary apportion-ment, none have been retained as a viable alternative.28 The arm’s-lengthprinciple thus became the cornerstone of article 9 of the OECD model taxconvention and the basis for negotiations between competent authorities ofvarious tax administrations pursuant to the mutual agreement proceduresunder the tax treaties between their respective countries.

It is important to keep in mind that OECD members generally deal witheach other through income tax conventions based on the OECD model taxconvention and that, in order for such a convention to be negotiated be-tween any two specific members, it is generally accepted that there is aneed for the existence of a comprehensive tax system as well as broadlysimilar tax rates (rather than the absence of taxation) within both con-tracting states. Therefore, between OECD members, it is not so much theavoidance of taxation that is a concern to both tax jurisdictions and mul-tinationals alike, but rather the proper allocation of profits in order toavoid the taxation of the same income in the hands of different persons(economic double taxation). Is double taxation such a bad thing? As anirrecoverable economic cost,29 double taxation represents a strong im-pediment to the international flow of goods, services, and capital.30

Consequently, it cripples free trade and stands in the way of globalizationas an unacceptable levy that discourages investors from doing business inthe jurisdictions involved. Double taxation must thus be remedied for thesake of both multinational enterprises and tax jurisdictions.

The harmonization between the OECD and the Canadian versions ofthe arm’s-length principle constitutes an essential element in eliminatingtrade barriers and allowing multinational enterprises carrying on businessin Canada to not be discriminated against, vis-à-vis their counterpartsdealing at arm’s length, through potential double taxation. In this respect,the draft circular indicates at paragraph 6 that Revenue Canada supportsand “proposes to follow the OECD Guidelines.” Arguably, for RevenueCanada to be able to successfully base itself on the OECD guidelines forthe purpose of the administration of transfer pricing in Canada, the Cana-dian basic frame of reference (proposed subsection 247(2) of the Act)must be in line with its OECD counterpart.

28 See Jill C. Pagan and J. Scott Wilkie, Transfer Pricing Strategy in a Global Economy(Amsterdam: International Bureau of Fiscal Documentation, 1993), paragraphs 1.35 to1.37, where the authors suggest that the rationale for the OECD’s rejection of the globalformulary apportionment approach was “that it produced an arbitrary result and wouldrequire a renegotiation of the tax treaty network.”

29 One may argue that multinationals can pass on the cost of double taxation in theform of a markup of the price to the ultimate consumer; but such markups are not alwayspossible (for instance, where competitive forces preclude them), and there are other prob-lems such as timing and deadweight loss.

30 See the introduction to the OECD model tax convention, supra footnote 26, at I-1,paragraph 1.


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What Is the Arm’s-Length Principle?The OECD states that the arm’s-length principle is based on the compari-son of the conditions in controlled transactions with the conditions intransactions between independent enterprises.31 The OECD guidelines of-fer the following version of the arm’s-length principle as its “authoritativestatement”:

[When] conditions are made or imposed between . . . two [associated] en-terprises in their commercial or financial relations which differ from thosewhich would be made between independent enterprises, then any profitswhich would, but for those conditions, have accrued to one of the enter-prises, but, by reason of those conditions, have not so accrued, may beincluded in the profits of that enterprise and taxed accordingly.32

This statement is extracted from article 9 of the OECD model tax conven-tion and extensively elaborated upon in the OECD guidelines to deal with,inter alia, the methods that are appropriate in applying the arm’s-lengthprinciple, the issue of setting transfer prices for intangible property, theprovision of intragroup services, and cost contribution arrangements.

Because the arm’s-length principle evaluates transactions between af-filiates in comparison with transactions between parties dealing at arm’slength, it is felt that its application levels the playing field between mul-tinational enterprises and independent entities and actually acts as anincentive to global trade.33

Do the New Rules Meet the Arm’s-Length Principle?A side-by-side examination of proposed subsection 247(2) and the OECDstatement of the arm’s-length principle reveals that, while the Canadianversion of this standard is more similar in wording than the versionsfound in some other countries,34 there are some differences between theCanadian phraseology and the language used in the OECD guidelines. Inthis section, we identify three principal differences in phraseology andconsider whether they give rise to any differences in substance.

31 OECD guidelines, supra footnote 2, at paragraph 1.15.32 Ibid., at paragraph 1.6.33 Ibid., at paragraph 1.7.34 For instance, in the United States, IRC section 482 reads as follows: “In any case of

two or more organizations, trades, or businesses (whether or not incorporated, whether or notorganized in the United States, and whether or not affiliated) owned or controlled directly orindirectly by the same interests, the Secretary may distribute, apportion, or allocate grossincome, deductions, credits, or allowances between or among such organizations, trades, orbusinesses, if he determines that such distribution, apportionment, or allocation is necessaryin order to prevent evasion of taxes or clearly reflect the income of any such organizations,trades, or businesses. In the case of any transfer (or license) of intangible property (withinthe meaning of section 936(h)(3)(B)), the income with respect to such transfer or licenseshall be commensurate with the income attributable to the intangible.”


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The Triggering Event for the Application of theArm’s-Length PrincipleThe first difference is situated at the level of the triggering event for theapplication of the arm’s-length principle. In the words of the OECD, it iswhen there is a difference between the conditions made or imposed be-tween associated enterprises35 in their commercial or financial relationsand the conditions that would be made between independent enterprisesthat article 9 of the OECD model tax convention and its transfer-pricingrules apply. In contrast, proposed subsection 247(2) of the Act stipulatesthat the Canadian transfer-pricing rules will apply where a taxpayer and anon-resident person with whom the taxpayer does not deal at arm’s lengthare participants in a transaction36 and the terms or conditions made orimposed between the participants in respect of the transaction differ fromthose that would have been made between persons dealing at arm’s lengthor the transaction itself would not have been entered into between per-sons dealing at arm’s length.

Thus, while the OECD refers to differences in “conditions . . . in . . .commercial or financial relations,” the proposed legislation refers to dif-ferences in the terms, conditions, or nature of a transaction. While thedifferences between these two formulations are relatively small, they none-theless suggest a potentially significant difference in orientation. Theproposed legislation, by referring to individual transactions, suggests atransaction-by-transaction analysis of transfer prices. The OECD, on theother hand, by focusing on “commercial or financial relations,” suggeststhat all commercial or financial relations between related taxpayers shouldbe considered in making a transfer-pricing adjustment. This brings intoplay the seeming contradiction between an approach that is purely trans-actional and one that allows for year-end or aggregative analysis.

Revenue Canada has long maintained the position that Canada’s transfer-pricing rules are to be applied on a transaction-by-transaction basis.37

35 While the OECD guidelines use the expression “associated enterprises,” this expres-sion does not bear the same meaning as that found in subsection 256(1) of the Act.Instead, as stated in article 9 of the OECD model tax convention, supra footnote 26, it ismeant to apply where

(a) an enterprise of a Contracting State participates directly or indirectly in themanagement, control or capital of an enterprise of the other Contracting State, or

(b) the same persons participate directly or indirectly in the management, con-trol or capital of an enterprise of a Contracting State and an enterprise of the otherContracting State.

Thus, the OECD concept of associated enterprises is essentially the same as the concept of tax-payers not dealing at arm’s length for the purposes of proposed subsection 247(2), save, perhaps,for the Canadian reference to partnerships, as will be discussed subsequently in this article.

36 For the sake of brevity, in this discussion “transaction” is understood to include“series of transactions.” The term “transaction” is defined in proposed subsection 247(1)as including an arrangement or event for the purposes of proposed section 247.

37 Paragraph 6 of Information Circular 87-2, February 27, 1987, states that subsections69(2) and (3) must be “applied to each transaction.”


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Paragraph 13 of the draft circular reiterates this position, indicating that,in Revenue Canada’s view, the “arm’s length principle requires that . . .each transaction between parties . . . be carried out under terms and con-ditions”38 that would have been present between parties dealing at arm’slength. The OECD, in contrast, while expressing a preference for a transaction-by-transaction analysis, also seems to leave the door open, in somecircumstances, to the use of a year-end or aggregative analysis in theevaluation of transfer prices. In this respect, the OECD’s stated preferencefor transaction-by-transaction analysis cannot erase the fact that the OECDitself presents as the authoritative statement of the arm’s-length principlean analysis based on “commercial or financial relations” and a remedybased on the adjustments of “profits” between enterprises. Thus, it is easyto imagine that when the Canadian tax authorities set out to harmonizeCanada’s version of the arm’s-length principle with the OECD’s, the seem-ing contradiction between the transaction-based approach and the year-endor aggregative approach would resurface. Indeed, the draft circular’s re-luctant acceptance of the profit-split method and the TNMM as appropriate,albeit low-ranked, transfer-pricing methods suggests that some confusionon this point has slipped into Revenue Canada’s position. However, theextent of such confusion should not be exaggerated. The draft circulardescribes the profit-split method and the TNMM as “transactional profitmethods (emphasis added),” and the statutory articulation of the arm’s-length principle in proposed subsection 247(2) clearly adopts a transactionalframework. This raises two fundamental questions: what is the arm’s-length principle, and what does it require? At its very core and in itssimplest form, it requires that dealings between non-arm’s-length partiesbe conducted in a manner consistent with dealings between unrelatedparties. The difficulty with applying such a principle on a strict per-transaction basis is that even unrelated parties may not address certainsituations on that basis. For instance, where unrelated parties transferbetween themselves a bundle of tangible goods, services, and even intan-gible goods, the unrelated parties may not address the situation on aper-transaction basis but rather may look at the overall profitability of theentire set of transactions. Even where only one tangible good is trans-ferred but in a repetitive manner over the course of the year, unrelatedparties may not necessarily look at the profitability of each transactionbut instead may look at the profitability of the entire year or even theprofitability of a cycle of years. Hence, it is not only the per-transactionanalysis and the benefit derived from the particular transaction that is andshould be looked at by the tax authorities, but rather all relevant factorsthat would be considered by unrelated parties. Such factors include over-all profitability, whether an industry is cyclical, the hurdle rate, and theentire panoply of elements that come into the decision-making processwhen unrelated parties enter into commercial relations.

38 Emphasis added.


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Adjusting the Quantum or the Nature of the AmountsThe second difference is situated at the level of the remedy applied oncethe triggering event has occurred. Pursuant to article 9 of the OECD modeltax convention, the action triggered is an adjustment to the profits of theenterprise. In contrast, Canada’s proposed legislation calls for adjust-ments to the quantum or nature of “any amount” that would be determinedfor purposes of the Act. In determining what amounts will be adjusted, itis important to remember that the proposed legislation adopts a transaction-by-transaction analysis of a taxpayer’s transfer prices. Thus, generally,the amounts that will be adjusted are the price applied to the transactionand all other amounts that are affected by that price (that is, profit, tax-able income, capital cost, etc.).

In this respect, perhaps the most important distinction between theCanadian conception of the arm’s-length principle and the OECD concep-tion once again relates to the question of year-end versus transactionalanalysis. This can best be illustrated by way of an example. Suppose aCanadian taxpayer were to enter into two transactions with a related non-resident, one of which took place at an unreasonably low price and theother at an unreasonably high price. While the OECD guidelines suggestthat, in evaluating the commercial and financial relations between theparties, each transaction should be analyzed separately, the OECD formu-lation of the arm’s-length principle also seems to suggest that bothtransactions should be considered and that if one results in a beneficialadjustment and the other a detrimental adjustment, such adjustments shouldbe offset against each other. The appropriateness of considering all trans-actions and netting them one against the other is highlighted by the factthat the OECD formulation of the arm’s-length principle refers to theremedy as an adjustment to “profits,” which, by its very nature, is anaggregative concept. In contrast, the Canadian formulation of the arm’s-length principle, by specifically focusing on a transaction-by-transactionanalysis and on an adjustment of “amounts” arising from such transac-tions, seems to move away from an aggregative approach that permitssetoff. In this respect, the non-aggregative nature of the Canadian ap-proach is specifically reflected in proposed subsection 247(10), whichprovides that the minister need not make transfer-pricing adjustments thatare beneficial to a taxpayer.

Finally, with respect to the remedy to be applied under the arm’s-length principle, we note that, in addition to permitting an adjustment tothe quantum of “amounts” determined in respect of a transaction, pro-posed subsection 247(2) contemplates the recharacterization of the natureof such amounts in circumstances where arm’s-length parties would nothave entered into the transaction in question. This recharacterization powermay, at first glance, seem to fall outside the OECD’s authoritative state-ment of the arm’s-length principle. However, the OECD guidelinesnonetheless refer specifically to the possibility of recharacterizing thenature of certain transactions and provide examples of circumstances inwhich this remedy might be appropriate. First, the OECD agrees that some


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loans may be more appropriately regarded as contributions to equity capi-tal.39 Second, where an independent enterprise would not have been willingto sell an intangible that was transferred between associated enterprises,the OECD agrees that the sale may be recharacterized as a licensing agree-ment and a royalty may be deemed to be payable.40 Thus, although thewording of article 9 of the OECD model tax convention may, at firstblush, not seem to entertain the recharacterization of the nature of trans-actions, it appears well settled that the OECD and its members considerthat it does; consequently, Canada’s express inclusion of such a power inproposed subsection 247(2) does not appear to depart from the OECD’sunderstanding of the arm’s-length principle.

Partners and PartnershipsThe third apparent difference between the Canadian and the OECD ver-sions of the arm’s-length principle is that proposed section 247 appliesexpressly to partners and partnerships, as well as other taxpayers, whereasthe OECD guidelines refer only to enterprises. The term “enterprise” isdefined in article 3 of the OECD model tax convention as follows:

[T]he terms “enterprise of a Contracting State” and “enterprise of the otherContracting State” mean respectively an enterprise carried on by a residentof a Contracting State and an enterprise carried on by a resident of theother Contracting State.

Thus, it appears that an enterprise is a business or other commercial activ-ity carried on or performed by a resident of a contracting state.41 Since apartnership can carry on a business and perform commercial activities, theconcept of enterprise, in and of itself, does not seem to preclude theapplication of the arm’s-length principle to partnerships. However, thequestion that remains is whether or not a partnership can be resident in acontracting state for purposes of the OECD model tax convention.

In this respect, the commentary on article 1 of the OECD model taxconvention, which deals with the persons to whom the convention applies,provides that where in a given country a partnership is treated as a taxableunit, the partnership may invoke the provisions of the convention. On theother hand, if the partnership is disregarded for taxation purposes and onlythe individual partners are liable to tax on their share of the partnershipincome, “the application of the Convention to the partnership as suchmight be refused, at least if no special rule covering partnerships is pro-vided for in the Convention.”42 However, in such circumstances, the activityof the partnership would generally be considered to be an activity of thepartners of the partnership, and hence the partners may rely on income tax

39 See OECD model tax convention, supra footnote 26, at paragraph 2 of the commen-tary on article 9, and OECD guidelines, supra footnote 2, at paragraph 1.37.

40 See OECD guidelines, supra footnote 2, at paragraphs 1.10 and 1.37.41 See, for instance, OECD model tax convention, supra footnote 26, at article 7.42 Ibid., at paragraph 3 of the commentary on article 1.


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treaties to which their country of residence is a party. In light of the above,it may be inferred that the arm’s-length principle, as enunciated by theOECD, is meant to apply directly to partnerships only when partnershipsare treated by the domestic tax legislation as non-fiscally transparent enti-ties. Otherwise, the arm’s-length principle will bring partnerships into playonly in the determination of each partner’s share of the partnership’s income.

The new rules achieve much the same result, but by a different route.Although for Canadian tax purposes partnerships are not persons but aretreated as flowthrough entities, the new rules are said to apply to partner-ships where they are involved in cross-border transactions with persons orpartnerships with whom they do not deal at arm’s length. However, aspartnerships remain flowthrough entities, the tax consequences of suchapplication will in fact be felt only at the partner level, as is generally thecase under the OECD formulation.

The question of when a partnership deals at arm’s length with a personor another partnership is somewhat unclear. This determination is not,however, a new issue created by proposed section 247. It was previouslyraised by other provisions of the Act, such as paragraph 13(7)(e), subsec-tion 14(3), subparagraph 18(9)(d)(i), and paragraph 96(2.2)(c). InInterpretation Bulletin IT-419R, dated August 24, 1995, Revenue Canadaoffers the following views in respect of this determination:

20. In situations when one partner is in a position to control a partner-ship, either through ownership of a controlling interest or through a mandatevested in the partner by his partners, that partner is not considered to bedealing at arm’s length with that partnership. However, when a partner isnot in position to control a partnership in which the partner has an interest,and that partner has little or no say in directing the operations of thepartnership, it is generally recognized that the partner is dealing at arm’slength with the partnership.

21. As a general rule, it is presumed that partners deal with each otheron an arm’s-length basis in transactions outside of their partnership activ-ity, although their partnership in business would be a factor to be consideredin any other transaction between them.43

In addition, in a few other interpretations, Revenue Canada has takenthe position that, where partners act in concert to control a partnership,those partners would be viewed as not dealing at arm’s length with thepartnership. When confronted with the position that it is one of the crite-ria of partnerships that members carry on business in common with aview to profit and, accordingly, all partners probably deal with their part-nership in a non-arm’s-length manner, Revenue Canada based itself onthe predecessor to the second sentence of paragraph 20 of IT-419R,44

which stated that Revenue Canada was prepared to recognize that a partner

43 These views are consistent with earlier views expressed by Revenue Canada: seeRevenue Canada document no. 5-6721, November 23, 1988.

44 Interpretation Bulletin IT-419, July 10, 1978, paragraph 15.


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and the partnership “may” deal at arm’s length in that given situation. Rev-enue Canada also stated that it considered it a reasonable presumptionthat the fewer the number of partners, the greater the likelihood that thepartners would not deal with the partnership at arm’s length.45 In anothertechnical interpretation, Revenue Canada dealt with seven different situa-tions and put forward its view, in principle, on whether a partnership anda corporation were dealing at arm’s length.46 In this respect, it appearsthat Revenue Canada would generally apply the same treatment as it doesbetween shareholders and a corporation by considering an interest in the part-nership as the equivalent of a shareholding in a corporation. However, Rev-enue Canada also states that all situations are highly factual and that onlya consideration of all the relevant facts can lead to a proper determination.47

For limited partnerships, Revenue Canada has expressed the opinionthat where a limited partnership has only one general partner, that generalpartner will not normally deal at arm’s length with the limited partnershipbecause it will generally control the partnership. Revenue Canada hasalso noted that where the general partner is a wholly owned subsidiary ofthe sole limited partner, the limited partnership may not be dealing atarm’s length with the limited partner because the limited partner has defacto control of the limited partnership.48

While further certainty would definitely be welcome in the treatmentof partnerships for the purposes of the determination of whether partiesare dealing at arm’s length, it appears that the difference in wordingbetween the OECD and the Canadian versions of the arm’s-length princi-ple does not give rise to material discrepancies in application.

THE NEW RULES: LEGISLATION BYINFORMATION CIRCULARThe proposed legislation provides a relatively general and basic frame-work for the transfer-pricing regime in Canada. It articulates thearm’s-length principle to be applied in evaluating Canadian transfer-pricingpractices, it sets out in broad detail required contemporaneous documen-tation, it authorizes Revenue Canada to make adjustments in respect ofnon-arm’s-length cross-border transactions to ensure that those transactionsproperly reflect the arm’s-length principle, and it imposes penalties oncertain taxpayers that are subject to such transfer-pricing adjustments.However, while the basic framework is set out in the proposed legislation,it is the draft circular that elaborates upon and gives meaning to thisstructure. Thus, as has historically been the case, Canada’s redesignedtransfer-pricing landscape is substantially defined not in the legislation,

45 Revenue Canada document August 1990-340.46 Revenue Canada document no. 5-8399, December 29, 1989.47 In fact, in response to a ruling request, Revenue Canada answered that it generally

would not rule on whether a partner who is not in a position to control a partnership deals atarm’s length with that partnership: Revenue Canada document no. 3-2421, July 26, 1989.

48 See Revenue Canada document May 1991-179 and document no. 5-7883, June 16, 1989.


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but in one of Revenue Canada’s administrative publications. This ap-proach raises fundamental questions about the extent to which RevenueCanada and the taxpayer are required to comply with the transfer-pricing“rules” set out in the draft circular, and the extent to which the courts, inapplying the proposed legislation, may decide to diverge from such “rules.”

The Role of Information Circulars andInterpretation BulletinsIn 1970, Revenue Canada introduced two new series of publications, in-formation circulars and interpretation bulletins. Information Circular 70-1described the respective functions of these publications as follows:

Information Circulars will aim at informing the general public regardingprocedural matters relating to the Income Tax Act, the Estate Tax Act, andthe contribution provisions of the Canada Pension Plan; in addition, theywill be a means of announcing changes in organization, personnel, andoperating programs as well as other administrative developments of generalinterest to broad segments of the tax paying public.

Interpretation Bulletins . . . will be of particular interest to lawyers, ac-countants, and others who are engaged in day-to-day tax practice. As theirname implies, the purpose of these bulletins will be to give, from time totime, the Department’s interpretation of sections of the laws it administers;an equally important purpose will be to announce significant changes in theDepartment’s interpretation and the effective dates of any such changes[emphasis added].49

In light of these statements, it is surprising that the new transfer-pricingpublication takes the form of an information circular and not an interpre-tation bulletin, in that its content seems directed more to the interpretationof the proposed legislation than to the provision of mere procedural infor-mation. For example, the draft circular provides Revenue Canada’sinterpretation of the arm’s-length principle set out in the proposed legis-lation, the transfer-pricing methods that will be relied upon in determiningwhether an arm’s-length transfer price has been established, the penaltyprovisions, and the contemporaneous documentation requirements. Theseand other interpretations in the draft circular appear to impose specificrequirements on taxpayers engaged in transactions governed by the Cana-dian transfer-pricing regime, requirements that often are not expressly setout in the underlying legislation. The question that must be addressed isthe extent to which these interpretations of the legislation are binding ontaxpayers.

The Legal Enforceability of Revenue Canada’sInterpretation Bulletins and OtherAdministrative PronouncementsThe jurisprudence has clearly held that statements and publications byRevenue Canada that purport to interpret legislative requirements are not,

49 Information Circular 70-1, August 25, 1970, paragraphs 2 and 3.


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in and of themselves, binding as law, although they may, in certain cir-cumstances, be of persuasive value in the interpretation of ambiguousprovisions of the Act. This position was described as follows in MattabiMines Ltd. v. Minister of Revenue (Ontario), where Wilson J, writing forthe court, stated:

Crucial to a resolution of this issue is an understanding of the legal effect ofadministrative practice as publicized in Interpretation Bulletins. As alreadymentioned, the latter are not authoritative sources for the interpretation oftaxing statutes. As Cattanach J. put it in Southside Car Market Ltd. v. TheQueen, [1982] 2 F.C. 755 (T.D.) at 770: “an interpretation is not law until sointerpreted by a court of competent jurisdiction.” The same judge noted inStickel v. M.N.R., [1972] F.C. 672 (T.D.) at 684, that “[t]he Deputy Ministerdoes not have the power to legislate.” Interpretation Bulletins, however, dohave some persuasive force where there is an ambiguity in the legislation.50

The courts’ willingness to refer to Revenue Canada’s administrativestatements to assist them in interpreting ambiguous statutory provisionsdoes not mean that ambiguity must necessarily be resolved in accordancewith such statements. To find otherwise would be to provide RevenueCanada with a de facto rule-making authority wherever there is ambiguityin the Act (of which there is plenty). In this respect, in L. Vaillancourt v.The Queen,51 the Federal Court of Appeal suggested that interpretationbulletins may be particularly persuasive in resolving ambiguity wherethey are invoked by a taxpayer in favour of his position and againstRevenue Canada’s position.52 This is precisely the point made by PierreAndré Côté in a 1991 Canadian Tax Journal article,53 where he reportedthat a review of judicial decisions suggested that interpretation bulletinsand administrative statements appear to be more persuasive when they arerelied on by a taxpayer than when they are relied on by the minister.54

50 [1988] 2 CTC 294, at 305 (SCC). See also G.A. Nowegijick v. The Queen, [1983]CTC 20 (SCC); Harel v. Dep. Min. of Rev. (Que.), [1977] CTC 441 (SCC); and L.Vaillancourt v. The Queen, [1991] 2 CTC 42 (FCA).

51 Supra footnote 50.52 In particular, the Federal Court of Appeal stated, ibid., at 48, “[T]he courts are

having increasing recourse to such Bulletins and they appear quite willing to see an ambi-guity in the statute—as a reason for using them—when the interpretation given in a Bulletinsquarely contradicts the interpretation suggested by the Department in a given case orallows the interpretation put forward by the taxpayer. When a taxpayer engages in businessactivity in response to an express inducement by the Government and the legality of thatactivity is confirmed in an Interpretation Bulletin, it is only fair to seek the meaning of thelegislation in question in that bulletin also.”

53 Pierre André Côté, “L’interprétation de la loi fiscale—quelques problèmes” (1991),vol. 39, no. 2 Canadian Tax Journal 258-87.

54 For instance, Côté states, ibid., at 271, “L’interprétation administrative est-elleinvoquée au soutien des prétentions de l’Administration ou de celles du contribuable?Cette question paraît déterminante. Une étude de 29 décisions où le tribunal a fait état del’interprétation par le fisc a révélé qu’elle a été suivie dans 18 cas, écartée dans 11. Parmiles 18 cas où elle a été suivie, 15 ont été décidés en faveur du contribuable, seulement 3 enfaveur du fisc.”


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Such a result is, as Côté suggested, intuitively pleasing. While a taxpayercannot rely on estoppel where the minister seeks to issue an assessmentthat is inconsistent with an interpretation of the Act put forward in aninterpretation bulletin or some other administrative statement, a court willlikely have a certain amount of sympathy for the taxpayer and may there-fore choose to interpret the Act so as to support the administrative positionrejected by the minister in assessing the taxpayer.

The fact that interpretation bulletins may not reflect an accurate orbinding statement of the law has effectively been recognized by RevenueCanada in Information Circular 70-1, which states that a fundamentalpurpose of interpretation bulletins is to provide “the Department’s inter-pretation of sections of the laws it administers.” It is important for thedepartment’s interpretation of the Act to be publicly disseminated and, inmost cases, taxpayers will act in conformity with the department’s statedpositions. However, ultimately, the department’s function is only to ad-minister and enforce the Act,55 not to reach final or binding decisions onlegislative interpretation. Any disputes between taxpayers and the depart-ment concerning their respective interpretations of the Act are to beresolved, ultimately, by the courts.56 In short, the department’s interpreta-tion can be neither determinative nor binding on a taxpayer.57

In addition to circumstances where an interpretation bulletin or otheradministrative statement is issued to provide an interpretation of a spe-cific statutory provision, administrative statements may be issued toprovide guidance regarding the circumstances in which Revenue Canadawill exercise a discretionary power granted under the Act. By a discre-tionary power, we are referring to a specific discretion conferred on theminister of national revenue (“the minister”) by a specific provision ofthe Act. For instance, pursuant to subsection 220(3.1), the minister may,at any time, waive or cancel any penalty or interest payable by a taxpayer.The Act, however, does not specify any factors that must be consideredby the minister in deciding how he will exercise such a discretionarypower. Where legislation confers such broad discretionary powers, ad-ministrative agencies often choose to publish guidelines concerning theexercise of those powers. Information Circular 92-258 serves precisely

55 Subsection 220(1) of the Act describes the minister’s duty as follows: “The Ministershall administer and enforce this Act and control and supervise all persons employed tocarry out or enforce this Act and the Deputy Minister of National Revenue may exerciseall the powers and perform the duties of the Minister under this Act.”

56 See, in this respect, division J of part I of the Act.57 The conclusion that where an interpretation bulletin outlines Revenue Canada’s in-

terpretation of the Act such an interpretation will not be binding on a court, which wouldbe free to interpret the Act otherwise, is consistent with the recent decision in ConsoltexInc. v. The Queen, [1997] 2 CTC 2846 (TCC), in which Bowman J found that neitherRevenue Canada nor a taxpayer was bound by an agreement between the two that wasinconsistent with the provisions of the Act. The rationale behind this decision was thatneither party could alter the tax rules set out in the Act.

58 Information Circular 92-2, March 18, 1992.


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this purpose in respect of the broad discretion conferred on the ministerpursuant to subsection 220(3.1), by indicating the circumstances in whichthe minister may decide to waive interest and penalties. The courts havegenerally accepted the use of administrative statements to structure anadministrative agency’s discretion, so long as the agency respects the factthat such statements are only general guidelines and the agency does notapply them as legalistic rules that effectively pre-empt the case-by-caseapplication of its discretionary powers. In this respect, administrative lawspecifically recognizes the “fettering” of discretion as a justification foroverturning an administrative agency’s exercise of its discretion. Whilethe mere issuance of administrative guidelines will not normally consti-tute fettering, and the courts are generally reluctant to overturn purelydiscretionary decisions by administrative agencies, if the “guidelines” are defacto rules and are applied as such, an administrative agency will likelybe found to have fettered its discretion.59 Accordingly, in the context ofproposed subsection 247(10), which specifically grants the minister dis-cretion in applying the transfer-pricing rules, the minister is free to decidehow he will exercise this discretion and to inform taxpayers of the gen-eral approach he will take. The courts will be unlikely to intervene unlesssuch guidelines effectively amount to rules and are legalistically appliedin a manner that unduly fetters the minister’s discretionary authority.

Keeping in mind these comments on the proper role of administrativestatements, we turn now to the content of the draft circular and considerthe force and effect of certain specific statements contained therein.

59 See, for instance, Maple Lodge Farms Ltd. v. Canada, [1982] 2 SCR 2, at 6-7, wherethe Supreme Court of Canada stated:

It is clear, then, in my view, that the Minister has been accorded a discretion unders. 8 of the Act. The fact that the Minister in his policy guidelines issued in theNotice to Importers employed the words: “If Canadian product is not offered at themarket price, a permit will normally be issued; . . .” does not fetter the exercise ofthat discretion. The discretion is given by the Statute and the formulation and adop-tion of general policy guidelines cannot confine it. There is nothing improper orunlawful for the Minister charged with responsibility for the administration of thegeneral scheme provided for in the Act and Regulations to formulate and to stategeneral requirements for the granting of import permits. It will be helpful to appli-cants for permits to know in general terms what the policy and practice of theMinister will be. To give the guidelines the effect contended for by the appellantwould be to elevate ministerial directions to the level of law and fetter the Ministerin the exercise of his discretion. Le Dain J. dealt with this question at some lengthand said, at p. 513:

The Minister may validly and properly indicate the kind of considerations bywhich he will be guided as a general rule in the exercise of his discretion(see British Oxygen Co. Ltd. v. Minister of Technology [1971] A.C. (H.L.)610; Capital Cities Communications Inc. v. Canadian Radio-Television Com-mission [1978] 2 S.C.R. 141, at pp. 169-171), but he cannot fetter his discretionby treating the guidelines as binding upon him and excluding other valid orrelevant reasons for the exercise of his discretion (see Re Hopedale Develop-ments Ltd. and Town of Oakville [1965] 1 O.R. 259).


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The Draft Circular’s Ranking of Transfer-Pricing MethodsThe draft circular indicates that Revenue Canada will rely on the transfer-pricing methods outlined in the OECD guidelines in order to determinewhether an arm’s-length transfer price is being used by a particular tax-payer. Consistent with the OECD guidelines, the draft circular expresses astrong preference for the traditional transactional transfer-pricing meth-ods (the CUP method, the resale price method, and the cost plus method),although the transactional profit methods (the profit-split method and theTNMM) will be considered acceptable where traditional methods are foundnot to produce a reliable estimate of the arm’s-length price. In the draftcircular, Revenue Canada indicates that it considers the TNMM to be amethod of last resort.

Revenue Canada’s position on the acceptability of various transfer-pricing methods raises interesting questions regarding the courts’ possibleview of alternative methods put forward by a taxpayer to support thereasonableness of its transfer-pricing practices. The proposed legislationis silent on the question of transfer-pricing methods. It merely requiresthat the terms and conditions be the same as those that would have beenagreed to between arm’s-length parties. Moreover, in this respect, neitherthe proposed legislation nor the accompanying technical notes specifi-cally refer to the OECD guidelines. Accordingly, in our view, neither theOECD guidelines nor the draft circular should bind a court with respect tothe question of the appropriate method to apply in evaluating a taxpayer’stransfer-pricing practices.60

This said, we acknowledge that a court might, at the very least, findthe list of accepted methods, both in the draft circular and in the OECDguidelines, to be of persuasive value in deciding whether a method not on

60 We are mindful, however, that the extent of the reliance placed by the courts on theOECD guidelines might be somewhat greater in the context of a transfer-pricing disputegoverned by one of Canada’s international tax treaties. In such circumstances, the OECDguidelines might be said to be similar to the commentary on the OECD model tax conven-tion and, hence, on the basis of The Queen v. Crown Forest Industries Ltd., [1995] 2 CTC64 (SCC), of high persuasive value in establishing the parameters of the internationaltreaty in question. In this respect, Vogel et al. suggest in Klaus Vogel on Double TaxationConventions, 3d ed. (Boston: Kluwer Law International, 1997), at 535, that the OECDguidelines have the same weight as the OECD commentary in regard to the interpretationof the OECD model tax convention. However, even if Canadian law were to accept theOECD guidelines as having the same value as the OECD commentary in interpreting aninternational treaty based on the OECD model tax convention, this position would not givethe transfer-pricing methodologies outlined in the OECD guidelines the force of law.Instead, they are merely of interpretative value in understanding the arm’s-length principlereflected in article 9 of the OECD model tax convention. Thus, where a taxpayer candemonstrate that a particular methodology produces an arm’s-length transfer price withinthe meaning of article 9 of the OECD model tax convention, it should be open to thecourts to accept that methodology regardless of its ranking or inclusion in the OECDguidelines. The OECD guidelines themselves seem to accept this position, supra footnote2, at paragraph 1.68: “Moreover, MNE groups retain the freedom to apply methods notdescribed in this Report to establish prices provided those prices satisfy the arm’s lengthprinciple in accordance with these Guidelines.”


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these lists but used by a taxpayer should be accepted by the court. How-ever, even if a court were to find that these lists were of persuasive value,this does not mean that they would be considered binding or determina-tive. Moreover, there would remain the question, which is perhaps of evengreater interest, whether the court would also find the ordering of transfer-pricing methods outlined in the OECD guidelines and in the draft circularto be persuasive, and in particular the extent to which the court wouldrely on the comments in the draft circular to the effect that the TNMMshould be used as a method of “last resort.” In this respect, we submitthat there may be greater latitude for the courts to accept lower-rankedmethods than is suggested in the draft circular, and that, as noted above,there may even be some latitude for the courts to accept methods that arenot actually mentioned in the draft circular. The key to obtaining suchacceptance by a court would be to provide persuasive expert evidence asto why a particular method results in a transfer price that meets the statu-tory enunciation of the arm’s-length principle set out in proposedsubsection 247(2). It is important to recall that neither the methodologiesnor the ordering found in the draft circular is legally binding on thecourts or on a taxpayer. Ultimately, whether prices meet the arm’s-lengthtest is a question entirely within the jurisdiction of the courts, applyingthe arm’s-length principle set out in the Act. If a taxpayer can convince acourt that the arm’s-length principle has been satisfied, and that the termsand conditions are those that would have been reached between arm’s-length parties, the fact that the taxpayer’s evidence is presented in theguise of a TNMM or CPM61 analysis or of some other method should notbe determinative. While Revenue Canada will likely do its utmost tocontest the use of any such methods, and in particular the TNMM andCPM, in our view, Revenue Canada must ultimately do more than merelyargue that it considers a particular methodology to be inappropriate (or,in the case of the TNMM, that it considers such methodology to be appro-priate only in the most extreme of circumstances). Instead, we submit, thedecision should rest on the court’s determination of whether a particularmethodology results in an appropriate estimation of an arm’s-length transferprice in the particular circumstances before the court.

61 We are mindful of the debate as to whether the TNMM and the CPM are the same.The United States considers that they are and accepts the use of the CPM. Likewise, NewZealand has endorsed the CPM as an acceptable transfer-pricing method (see sectionGD 13(7)(e) of New Zealand’s Income Tax Act 1994). However, despite these endorse-ments, the majority of the international community does not consider the CPM and theTNMM to be the same. Because the TNMM must be applied in a manner consistent withthe manner in which the cost plus and resale price methods are applied (including, pre-sumably, a higher degree of comparability than that necessary for the CPM—see OECDguidelines, supra footnote 2, at paragraph 3.26), it may be argued that the TNMM will findapplication on far fewer occasions than the CPM. It also may be suggested that if theTNMM requires the same amount or level of comparability as the cost plus or resale pricemethods, one might never be able to apply it because the ordering of the methodologieswould mandate the use of those other methods instead.


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“Reasonable Efforts”Proposed subsection 247(4) provides that certain contemporaneous docu-mentation must be maintained by a taxpayer in respect of a particulartransaction. In the absence of this documentation, the taxpayer will bedeemed not to have made reasonable efforts to determine appropriatetransfer prices with respect to the transaction and will be subject to theproposed new penalty provision in the event of a transfer-pricing adjust-ment. The proposed legislation provides that the contemporaneousdocumentation must include a description of the “data and methods con-sidered and the analysis performed to determine the transfer prices.” Asnoted earlier, paragraph 79 of the draft circular states, “In general, theDepartment considers that the making of reasonable efforts requires theapplication of a recommended method by the taxpayer.” In view of thisstatement, will a taxpayer’s reliance on a low-ranked method such as theTNMM be sufficient to satisfy the deeming rule in proposed subsection247(4)? This is a particularly important question given that a close equiva-lent of the TNMM, the CPM, is the method of choice generally used by USmultinationals in their so-called US penalty studies.

We suggested above that the courts might be willing to ignore RevenueCanada’s view of the relative ranking of various transfer-pricing methodsin evaluating a taxpayer’s transfer-pricing practices and determiningwhether an adjustment under proposed subsection 247(2) is appropriate.In our view, even where a court is unwilling to accept the transfer pricearrived at by a taxpayer using a particular method, on the basis that themethod is not considered appropriate, the court might be reluctant touphold the imposition of a penalty if it considered that reasonable effortswere made. Notwithstanding Revenue Canada’s disdain for the CPM andthe TNMM, there seems to be scope in the “reasonable effort” test for thecourts to find that the bona fide use of any transfer-pricing method, andparticularly an OECD-approved transfer-pricing method such as the TNMM,constitutes “reasonable efforts” in many circumstances. This is particu-larly so given that, as we noted previously, Revenue Canada itselfacknowledges that a “prudent business person” test is considered appro-priate in the context of evaluating contemporaneous documentation.

The Recharacterization of TransactionsProposed subsection 247(2) provides Revenue Canada with the authorityto recharacterize a transaction and the amounts determined in respect ofthe transaction where the transaction is not one that would have beenentered into between persons dealing at arm’s length. As a result of sig-nificant criticism from the tax community, the recharacterization poweroriginally set out in the proposed legislation has been somewhat narrowedby the recently released NWMM. Specifically, the NWMM provides for theaddition of proposed subparagraph 247(2)(b)(ii), which specifies that, fora transaction to be recharacterized, the transaction under review not onlymust be one that would not have been entered into between persons deal-ing at arm’s length, but also must be one that can reasonably be considered


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not to have been entered into primarily for bona fide purposes other thanto obtain a tax benefit.

The expression “tax benefit” used in proposed subsection 247(2) isdefined in proposed subsection 247(1) as meaning “a reduction, avoid-ance or deferral of tax or other amount payable under [the] Act or anincrease in a refund of tax or other amount under [the] Act.” This defini-tion is the same as the definition of “tax benefit” currently found insection 245 of the Act (the general anti-avoidance rule, or “GAAR”). Aninteresting difference between GAAR and proposed subsection 247(2) isthat GAAR cannot be applied to recharacterize a transaction if “it mayreasonably be considered that the transaction would not result directly orindirectly in a misuse or abuse of the provisions of [the] Act or an abusehaving regard to the provisions of [the] Act read as a whole.” Such an“object and spirit” exception is notably absent from the recharacterizationpower in proposed subsection 247(2).

Notwithstanding the relative breadth of the statutory recharacterizationpower in proposed subsection 247(2), in paragraphs 18 to 20 of the draftcircular, Revenue Canada suggests that this power will be used only inlimited circumstances:

18. The Department generally accepts business transactions as they arestructured by the parties. However, as indicated in the OECD Guidelines,there may be limited instances where it is necessary to recharacterize atransaction for tax purposes. The OECD Guidelines identify two types ofsituations where the recharacterization of a transaction would be considered.

19. In the first situation, the substance of a transaction differs from itsform. The example provided in the OECD Guidelines involves an invest-ment in a related enterprise in the form of interest-bearing debt wherearm’s length parties would have structured their investment as a subscrip-tion of capital. However, where the thin capitalization rules in subsection18(4) through 18(8) of the Act could apply to such a transaction, the trans-action is unlikely to be recharacterized.

20. In the second situation, the transaction differs from that which inde-pendent enterprises behaving in a commercially rational manner would haveentered into and the structure of the transaction makes it nearly impossibleto determine an appropriate transfer price. In the example provided in theOECD Guidelines, a taxpayer performing research sells, for a lump sumpayment, unlimited entitlement to the intellectual property it is developing.Arm’s length parties would not have structured the transaction in this man-ner. In such cases, the Department might seek to recharacterize thetransaction, for tax purposes, as a form of continuing research agreement.

This position is consistent with statements in the OECD guidelines tothe effect that, while in exceptional circumstances it may be “both appro-priate and legitimate for a tax administration to consider disregarding thestructure adopted by a taxpayer,”62 as a general rule this should be avoided.Paragraph 1.36 of the OECD guidelines reads as follows:

62 OECD guidelines, supra footnote 2, at paragraph 1.37.


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A tax administration’s examination of a controlled transaction ordinarilyshould be based on the enterprise as it has been structured by them, usingthe methods applied by the taxpayer insofar as these are consistent with themethods described in Chapter II and III [of the guidelines]. In other thanexceptional cases, the tax administration should not disregard the actualtransactions or substitute other transactions for them. Restructuring of le-gitimate business transactions would be a wholly arbitrary exercise theinequity of which could be compounded by double taxation created wherethe other tax administration does not share the same views as to how thetransaction should be structured.

While other portions of the draft circular, in particular those dealing withcontemporaneous documentation and transfer-pricing methods, appear to beaimed at establishing new rules and conditions (in addition to those specifi-cally set out in the legislation) that Revenue Canada expects a taxpayer tocomply with, the portion of the draft circular dealing with the recharacter-ization power in proposed subsection 247(2) appears to be intended to easetaxpayer concerns by placing limitations on the broad wording of the stat-ute. While such administrative statements may be reassuring to the taxpayer,they are no substitute for carefully drafted legislative provisions that avoidoverbreadth. In this respect, we stress once again that administrative state-ments cannot override the statute. Despite Revenue Canada’s suggestion thatit will only infrequently use the recharacterization power in proposed sub-section 247(2), that power remains in place as a sword hanging over theheads of taxpayers. The impact of the limiting statements in the draft circu-lar is of particular concern given that the power conferred by proposedsubsection 247(2) is not discretionary. Instead, the subsection states thatwhere certain conditions are met, the department “shall” adjust the quantumand nature of amounts otherwise determined. It would have been preferableif the proposed legislation had been more narrowly drafted rather than “lim-ited” by statements of intent in an information circular.

Proposed Subsection 247(10)As we noted earlier, proposed subsection 247(10) provides the ministerwith the discretion to not give effect to a beneficial transfer-pricing adjust-ment that would otherwise be required under proposed subsection 247(2).In this regard, it would have been helpful if the draft circular had specifiedthe various factors that may be considered by the minister in determininghow and when such discretion will be exercised. As the foregoing discus-sion indicates, the draft circular contains detailed statements regarding theinterpretation of other aspects of the proposed legislation, which arguablyamount to a set of extralegislative rules intended to supplement the statu-tory provisions themselves. It is unfortunate that in respect of thediscretionary power granted by proposed subsection 247(10), where it wouldhave been entirely appropriate for Revenue Canada to provide detailedguidelines structuring its discretion, the draft circular is relatively silent.

SummaryOur review of the draft circular indicates that, in many respects, RevenueCanada is attempting to establish a series of administrative rules that will


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supplement the broad transfer-pricing structure set out in the proposedlegislation. In our view, while these administrative pronouncements mightbe considered by a court in interpreting the statutory transfer-pricingregime, they should not be determinative. Accordingly, taxpayers mightbe able to defend practices that are arguably within the letter of theproposed legislation but do not comply with the various additional “rules”set out in the draft circular. Conversely, certain broadly worded provi-sions of the proposed legislation, including the recharacterization powerin proposed subsection 247(2), will not necessarily be narrowed by sug-gestions in the draft circular that these provisions will be applied only inlimited circumstances.

THE NEW RULES: APAS NOW LOOK EVENMORE ATTRACTIVEAside from further exacerbating the need for the Canadian transfer-pricingadvisory industry, the proposed legislation can be expected to intensifythe search by multinational enterprises for a way to gain certainty inrespect of their transfer-pricing practices and to avoid the spectre of dou-ble taxation and onerous penalties. In this regard, the negotiation ofadvance pricing agreements (APAs) may be seen as an olive branch ex-tended by the Canadian tax authorities to multinational enterprises. Indeed,paragraph 100 of the draft circular indicates that, as long as an APAremains in effect and a taxpayer complies with its terms, no transfer-pricing adjustment should arise and consequently no penalty would beapplicable to the transactions covered by the APA. Although any relieffrom the potential application of the penalties is welcome, one may pon-der why the penalties are couched in the draft legislation with a deemingrule ensuring their almost automatic application, while the only relief insight takes the form of an administrative statement which, as we notedearlier, is not legally binding and, moreover, can be overridden at theminister’s discretion.

An APA is an agreement between a taxpayer and the tax authoritieswhereby the parties agree on a particular transfer-pricing methodology tobe applied to a specific set of transactions for a specified term. There aregenerally two types of APAs—unilateral and multilateral.

Unilateral APAs generally offer no protection against double taxation,although they do provide highly desirable certainty from a Canadian do-mestic standpoint. There is no legal basis for unilateral APAs outside thegeneral power of the minister of national revenue to administer the Act.Accordingly, the basis for unilateral APAs is equivalent to that of advancetax rulings.63 Even though unilateral APAs constitute a discretion on thepart of the minister, it has been argued that they are legally binding on the

63 See Information Circular 70-6R3, December 30, 1996, introducing advance incometax rulings, and Information Circular 94-4, December 30, 1994, which deals with APAs.


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minister once concluded;64 however, whether or not this is in fact the caseis the subject of significant debate.65

Multilateral APAs (often referred to as bilateral APAs), on the otherhand, are generally based on the mutual agreement procedures in Cana-da’s various tax treaties. For instance, article XXVI of the Canada-USconvention66 provides that a taxpayer may request competent authorityassistance if it considers that the actions of either Canada or the UnitedStates will result in taxation not in accordance with the convention. Thus,the mutual agreement procedure provides a mechanism by which taxpayerscan address concerns about double taxation through a request to the com-petent authorities.67 Once a multilateral APA is concluded, it may be seenas a competent authority agreement pursuant to the mutual agreementprocedure. Since a multilateral APA therefore appears generally to have abasis in a tax treaty, and accordingly might be said to be supported bysubsection 115.1(1) of the Act,68 it may be easier to argue that a multi-lateral APA is legally enforceable than to make the same claim for aunilateral APA.69 Returning to the question raised above as to why APAsare not formally recognized in the proposed legislation, one may arguethat, at least as regards multilateral APAs in a treaty context, such inclu-sion is unnecessary by virtue of the existence of subsection 115.1(1).Ultimately, however, while there may be some technical questions regard-ing the legal enforceability of APAs, and particularly unilateral APAs, thereality is that, like advance tax rulings, they are generally respected andtreated as binding by Revenue Canada. Thus, multinational enterprisesmay find that an application for an APA is an ideal means of bringingcertainty to the tax treatment of its transfer-pricing practices and of avoid-ing potential penalties and double taxation.

64 In support of this argument, see paragraph 3 of IC 94-4, supra footnote 63, whichstates, “An APA is considered to be a binding agreement between a taxpayer and theDepartment.”

65 See Vincent, supra footnote 5, at 29-32, for a detailed discussion of whether or notAPAs are legally binding.

66 The Convention Between Canada and the United States of America with Respect toTaxes on Income and on Capital, signed at Washington, DC on September 26, 1980, asamended by the protocols signed on June 14, 1983, March 28, 1984, March 17, 1995, andJuly 29, 1997.

67 The OECD also recognizes that APAs can be based on the mutual agreement proce-dure: see OECD guidelines, supra footnote 2, at paragraph 4.140.

68 Subsection 115.1(1) of the Act provides as follows: “Notwithstanding any otherprovision of this Act, where the Minister and another person have, under a provisioncontained in a tax convention or agreement with another country that has the force of lawin Canada, entered into an agreement with respect to the taxation of another person, alldeterminations made in accordance with the terms and conditions of the agreement shallbe deemed to be in accordance with this Act.”

69 See Vincent, supra footnote 5, at 29-32.


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CONCLUSIONIn conclusion, the new rules seem, in many respects, to have achievedtheir objective of harmonizing the Canadian transfer-pricing regime withthe OECD formulation of the arm’s-length principle. However, the harmo-nization is not complete. Most important, the OECD seems to leave moreroom for year-end and aggregative transfer-pricing analyses than do Cana-da’s new rules. Furthermore, many aspects of the OECD guidelines, whileincorporated in the draft circular, have no direct Canadian legislativefoundation; hence, it is unclear to what extent the courts will apply theseadministrative statements. In our view, courts may differ with RevenueCanada’s listing and ordering in the draft circular of the acceptable transfer-pricing methods and may choose to accept, in specific circumstances, theuse of the TNMM or CPM, or even of other methods not listed in the draftcircular, if those methods satisfy the arm’s-length test set out in proposedsubsection 247(2). However, until the courts have ruled on this point orthe Canadian tax authorities have altered their position, taxpayers whostray away from the methods currently approved by Revenue Canada riska statutory transfer-pricing adjustment and the associated penalties. In thefinal analysis, given the need for certainty in compliance and relief fromdouble taxation and penalties, APAs remain an extremely attractive alternative.

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Transfer Pricing in Canada: The Arm's-Length Principle and the New

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