Release date: February 28, 2012
Guest: Elisabeth Finch
Running time: 7:12 minutes
Elisabeth Finch discusses the Alberta Printed Circuits Transfer Pricing case including background details, the court’s decision and reasoning, and why taxpayers should pay attention to it.
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You’re listening to another episode of PwC’s Tax Tracks at www.pwc.com/ca/taxtracks. This series looks at the most pressing technical and management issues affecting today’s busiest tax directors.
Gerry Lewandowski: Today we’re joined by Elisabeth Finch, a Transfer Pricing partner in PwC’s Vancouver office. A materials scientist by training, Elisabeth has numerous years of diverse transfer pricing experience including the development of consistent global transfer pricing policies and resolution of transfer pricing disputes for numerous multinational clients. Thank you for joining us Elisabeth
Elisabeth: You’re welcome Gerry
Gerry: Today we’re here to talk about the Alberta Printed Circuits transfer pricing case, an important decision that came out of Canada in 2011. Elisabeth, can you give us some background on this case.
Elisabeth: Yes, sure. The company or taxpayer in the case is Alberta Printed Circuits Ltd. (or APCL). As you may guess, it’s a Canadian company, and it manufactures custom prototype circuit boards for sale to circuit board designers. The company was founded and owned by a couple, the Bambers. They eventually sold 25% of their shares to an employee, McMuldroch, who worked on software, design and set-up of the boards.
In a nutshell, APCL moved its set-up operations to Barbados and incorporated a company there called APCI, which was entitled to special tax treatment. McMuldroch eventually became a resident of Barbados and the director of APCI and continued with his set-up and some other IT-related responsibilities. With this new arrangement, APCL and APCI entered into an intercompany agreement whereby APCI would be paid a fixed fee that included a “set-up fee” based on the type of set-up performed and a “square inch fee,” considered a kind of bonus for providing non-set-up services. APCL used the CUP (or comparable uncontrolled price) method to determine the amount of the fee, which was equal to the fixed fee it charged its arm’s length customers. It also corroborated the fee through the use of external CUPs and the application of the transactional net margin method (or TNMM).
The CRA argued that there was duplication in the fixed fee charges (that is, between the set-up fees and the square inch fees), and also argued that APCL should have used the TNMM method instead of the CUP method to price the transactions. The court had to decide whether the set-up and square inch fees were reasonable and arm’s length.
Gerry: And how did the court decide?
Elisabeth: Well, the court essentially ruled largely in favour of APCL. It said there was no duplication of fees and that the CUP method was appropriate. In fact, the court found it perverse that the CRA did not consider the CUP an appropriate transfer pricing methodology under the circumstances.
However, the court also found that APCL could not support its transfer price for the non-set-up services, though it allowed a portion of the payments based on amounts conceded by the CRA. In this part of the decision the judge commented on the unreliability of the TNMM, which is what led him to reject APCL’s approach to pricing these services and the judge replaced it with his own idea (which I won’t go into, but which also doesn’t seem well founded).
Gerry: And why is this case significant? And, why should taxpayers take note of it?
Elisabeth: Well first, it’s one of very few TP cases that come to court in Canada. Most TP disputes are settled at the audit or appeal level, or through the competent authority process, and so never come into the public domain. The few TP cases that come to court are therefore the crumbs at the table for us in terms of providing guidance on the view of the Canadian tax court on TP issues. It’s also interesting that this case even came to court – the adjustments proposed by the CRA were pretty small in the scheme of things and it’s surprising the CRA and the taxpayer didn’t just settle. One thing we might learn from this case is that the CRA is willing to invest considerable resources into enforcing the Canadian transfer pricing rules when one of the related parties is in a low-tax jurisdiction.
For taxpayers, they’ll need to look very carefully at CUPs; transactions that may be commonly discarded as potential CUPs may be carefully considered by the court. In this case, the judge was satisfied that a fee for service that flowed through the Canadian entity without markup created a strong CUP, that is, the price paid by the third party customer for the service was the same as that paid to APCI and that was fine. This focus on CUPs is quite consistent with the approach taken by the tax court in the GlaxoSmithKline case, another relatively recent Canadian transfer pricing case.
Gerry: Would you say this is a trend we’re seeing then? Are Canadian courts favouring taxpayers over the CRA?
Elisabeth: No, not at all, unfortunately. In fact, while the CRA agreed with APCL on the pricing of the set up fees, as I mentioned, the adjustment sustained on the other services was a big proportion of the original adjustment, and the taxpayer left court with a relatively big adjustment still in place, about 25%. And we’ve heard that this case won’t be appealed, which isn’t surprising given the small numbers involved.
Gerry: Do you think these court decisions will prompt the CRA to be less aggressive in the future? I mean, in terms of pursuing issues all the way to court.
Elisabeth: Absolutely not! The CRA’s position in this case was really weakened by the flaws in their economic analysis, and particularly the fact that they had not even considered a CUP. There are plenty of TP audit cases where the CRA takes soundly supported economic positions that can be challenging to fight. And as it is generally in the interest of both the taxpayer and the CRA to settle TP cases before they reach court, the CRA’s approach will continue to be as aggressive as ever – there is really nothing for them to lose! (sadly, from the perspective of the taxpayer).
Gerry: So the message is our listeners need to continue to be diligent about their Transfer Pricing processes. For additional Transfer Pricing information, please visit our PwC website at www.pwc.com/ca/transferpricing. Thank you for joining us today Elisabeth.
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Through interviews with prominent PwC tax subject matter professionals, Tax Tracks is an audio podcast series that is designed to bring succinct commentary on tax technical, policy and administrative issues that provides busy tax directors information they require.