2016-0631631I7 Transfer pricing capital adjustment

Principal Issues: 1. Whether the Minister can modify the adjusted cost base of a capital property under subsection 247(2) even if, for the acquisition year, a Part I assessment is statute-barred? 2. Whether the Minister can reassess a taxpayer so as to increase a capital gain to take into account the aforesaid adjustment for a taxation year that is not statute-barred? 3. Whether a penalty under subsection 247(3) applies for the year of disposition or for the year of acquisition? 4. Whether there is a time limit restricting the Minister’s ability to initially assess a penalty under subsection 247(3) for a particular taxation year?

Position: 1. Yes. 2. Yes. 3. The acquisition year. 4. No.

Reasons: 1. A modification to the adjusted cost base of a capital property does not necessarily lead to an assessment under Part I for the year of acquisition. 2. Subsection 247(2) contemplates an adjustment to any amount for any taxation year of the taxpayer and not just the year in which the transaction arises. 3. Textual, contextual and purposive application of the law. 4. An assessment under Part XVI.1 with respect to a penalty under subsection 247(3) is separate and distinct from an assessment under Part I.

Author: Grégoire, Sylvain
Section: 152(4); 247

                                                                                                                                                        September 14, 2016

HEADQUARTERS
Mr. Mark Turnbull                                                                                                                            Income Tax Rulings
Manager                                                                                                                                          Directorate
International Advisory Services Section
International Tax Division                                                                                                                Sylvain Grégoire
344 Slater Street, 6th Floor, Canada Building
Ottawa, ON  K1A 0L5                                                                                                                     2016-063163

      Transfer pricing adjustments and penalties

We are writing in reply to your email of February 11, 2016 in which you requested our views on certain aspects of the transfer pricing rules in an illustrative fact pattern.

All statutory references herein are to the Income Tax Act (the “Act”).

Facts

•     A non-resident corporation (Forco) owns all the issued and outstanding shares of a corporation resident in Canada (Canco).

•     In Year X, Canco buys a capital property (other than a depreciable property) from Forco for $10,000,000.

•     In Year X+7, Canco sells the property for $15,000,000 to an arm’s length buyer and reports a capital gain of $5,000,000.

•     In Year X+9, the Minister conducts an audit of Canco’s Year X+7 taxation year. The Minister considers that the arm’s length purchase price of the property in Year X should be $1,000,000.

•     Canco’s Year X taxation year is statute-barred, but its Year X+7 taxation year is still open, for the purposes of assessment under Part I of the Act.

No assessment has ever been issued to Canco under Part XVI.1 of the Act in respect of Year X.

Your questions 

1.    Can the Minister make an adjustment to the property’s adjusted cost base pursuant to subsection 247(2) even though the non-arm’s length purchase was made in Year X? Can the Minister reassess Canco so as to increase its capital gain for the Year X+7 taxation year?

2.    If Canco did not make reasonable efforts to determine an arm’s length transfer price for the purchase in Year X, does a subsection 247(3) penalty apply to the adjustment in Year X or the adjustment in Year X+7? Does the penalty apply to the “transfer pricing capital adjustment” (“TPCA”) or the “transfer pricing income adjustment” (“TPIA”)? If it applies to the TPCA, is it statute-barred? Is a subsection 247(3) penalty assessable at any time in all cases?

Our comments

1.    Subsection 247(2) adjustment

A transfer pricing adjustment can be made by the Minister under subsection 247(2) when a taxpayer and a non-resident person with whom the taxpayer does not deal at arm’s length are participants in a transaction (or a series of transactions) and the terms or conditions made or imposed in respect of the transaction (or the series) between any of the participants in the transaction (or series) differ from those that would have been made between persons dealing at arm’s length. In this scenario, it is clear that the only relevant non-arm’s length transaction occurs in Year X. However, the consequence of the inflated purchase price arises only in Year X+7.

The question that arises is whether it matters that the Year X taxation year is, at the time of the audit, statute-barred from reassessment under Part I, pursuant to subsection 152(4), and whether this in any way precludes the assessment of a higher capital gain in Year X+7 on the disposition of the property.

In our view, there is no impediment to assessing the higher capital gains tax in Year X+7. We believe that such a result is supportable based on the overall scheme of section 247, in particular the fact that the “mid-amble” of subsection 247(2) contemplates an adjustment to any amount for any taxation year of Canco, and not just the year in which the transaction arises. This view is based on an approach whereby the amount initially adjusted under subsection 247(2) is the “adjusted cost base” (“ACB”) of the property in Year X which would then lead to a consequential increase to the capital gain in Year X+7.

Thus, a tax attribute, such as the ACB of a capital property, which was reported by Canco as being higher than the arm’s length price as a result of a non-arm’s length transaction that took place in a taxation year that is statute-barred, can, in our view, be adjusted for the purposes of reassessing a non-statute-barred taxation year, in this case the Year X+7 taxation year.

2.    Subsection 247(3) penalty

With respect to your questions concerning the application of subsection 247(3), it is important to point out that in order for the penalty to apply, it must be established, among other things, that a taxpayer has a TPCA or a TPIA. Such terms are defined in subsection 247(1). A TPCA is, among other things, a reduction under subsection 247(2) to the ACB of a capital property. A TPIA is any other adjustment under subsection 247(2) that would result in an increase in Canco’s income (other than an adjustment included in determining a TPCA of Canco for a taxation year). Thus, because an ACB adjustment could lead to both a TPCA and, by virtue of its effect in respect of a subsequent capital gain, a TPIA, the TPIA would be eliminated to the extent of the TPCA.

In the case at hand, it is our view that a TPCA, representing the reduction of the ACB of the capital property acquired by Canco in Year X, can be made at any time in respect of Canco’s Year X taxation year. Also, since the increased income amount resulting from the capital gain realized in Year X+7 would be exactly the same as the amount of the TPCA, there would be no separate TPIA in respect of the Year X+7 taxation year. Thus, a penalty can be assessed now in respect of Canco’s Year X acquisition of capital property, in accordance with subsection 247(3). In this regard, we note that such penalty is assessed under Part XVI.1 of the Act and is not in any way constrained by the limitation periods set out in subsection 152(4) in respect of assessments of Canco under Part I. Thus, an initial assessment under subsection 247(3) can be made at any time. However, pursuant to subsection 247(11), any additional assessment under subsection 247(3) for the year of the TPCA (Year X) would be subject to restriction based on an application of subsection 152(4) with respect to Year X and Part XVI.1.

Thus, to more specifically answer your questions, it is our view that:

1.    The Minister can make an adjustment to the property’s ACB pursuant to subsection 247(2) even though the non-arm’s length purchase was made in Year X, and the Minister can, in these circumstances, reassess Canco so as to increase its capital gain for the Year X+7 taxation year.

If Canco did not make reasonable efforts to determine an arm’s length transfer price for the purchase in Year X, a subsection 247(3) penalty can be applied to the adjustment in Year X, based on a TPCA, as it is not statute-barred. Also, an initial penalty assessment under subsection 247(3) can be assessed at any time.

We would also note that it appears that the only significance of the fact that the penalty is assessable in respect of Year X and not Year X+7 is that the deminimis rule in paragraph 247(3)(b) would take into account gross revenue for Year X and the other adjustments under paragraph 247(3)(a) that are aggregated with the particular TPCA would be other Year X adjustments. As for interest in respect of the penalty assessment, it is our view that it would be governed by paragraph 161(11)(c). Thus, interest would only accrue from the day the initial notice of the penalty assessment is sent.

For your information, unless exempted, a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Canada Revenue Agency’s electronic library. A severed copy will also be distributed to the commercial tax publishers, following a 90-day waiting period (unless advised otherwise), for inclusion in their databases. The severing process will remove all material that is not subject to disclosure, including information that could disclose the identity of the taxpayer. Should the taxpayer request a copy of this memorandum, they may request a severed copy using the Privacy Act criteria, which does not remove taxpayer identity. Requests for this version should be e-mailed to: ITRACCESSG@cra-arc.gc.ca.

We trust these comments will be of assistance, and thank you for your enquiry.

Dave Beaulne, CPA, CA
Section Manager
for Director
International Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch

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