2017-0729431R3 Transfer Pricing Adjustment and Earnings

Principal Issues: Where, as a result of a corresponding adjustment under foreign tax law pursuant to a mutual agreement procedure and a bilateral advance pricing arrangement, the taxable income and income taxes payable of a foreign affiliate have been reassessed by a foreign tax authority, would there be i) a re-computation of earnings and net earnings of the foreign affiliate for the relevant taxation years under subsection 5907(1) of the Regulations and ii) an addition to the earnings of the foreign affiliate under paragraph 5907(2)(f) of the Regulations for the relevant taxation years of the amount of the money retained but not included in computing the earnings of the foreign affiliate as a result of the corresponding adjustment?

Position: In the factual circumstances provided, i) yes and ii) yes.

Reasons: i) The corresponding adjustment and the resulting reassessment by the foreign tax authority changes the income or profit from active business of the foreign affiliate computed in accordance with the foreign tax law and the income taxes paid by the foreign affiliate in respect of that income or profit. ii) The money realized and retained by the foreign affiliate, but excluded from its income for foreign income tax purposes as a result of the corresponding adjustment by the foreign tax authority, would be "revenue, income, or profit" derived by the foreign affiliate for purposes of paragraph 5907(2)(f) of the Regulations.

Author: XXXXXXXXXX
Section: 247(2), 95(1), definition of "earnings" and "net earnings" under Reg. 5907(1); Reg. 5907(2)

XXXXXXXXXX                                                                                                   2017-072943

XXXXXXXXXX, 2018

Dear XXXXXXXXXX:

Re:   Advance Income Tax Ruling
        XXXXXXXXXX

This is in reply to your letter of XXXXXXXXXX requesting an advance income tax ruling on behalf of the above-named taxpayer. We also acknowledge the additional information provided to us in your emails, the last of which was on XXXXXXXXXX.

We understand that, to the best of your knowledge and that of the taxpayer, except to the extent described herein, none of the proposed transactions and/or issues in this letter are the same as or substantially similar to transactions and/or issues that are:

(i)   in a previously filed tax return of the taxpayer or a related person;

(ii)  being considered by a tax services office or tax centre in connection with a previously filed tax return of the taxpayer or a related person;

(iii) under objection by the taxpayer or a related person;

(iv)  the subject of a current or completed court process involving the taxpayer or a related person; or

(v)   the subject of a ruling request previously considered by the Directorate.

This document is based solely on the Facts, Proposed Transactions, Additional Information, and Purpose of Proposed Transactions described below. Any documentation submitted in respect of your request does not form part of the Facts, Proposed Transactions and Additional Information, and any references thereto are provided solely for the convenience of the reader.

Unless otherwise expressly stated, every reference herein to the “Act” or to a part, section or subsection, paragraph or subparagraph and clause or subclause is a reference to the relevant provision of the Income Tax Act (Canada), R.S.C. 1985 (5th Supp.) c.1, as amended from time to time and consolidated to the date of this letter and the Income Tax Regulations thereunder are referred to as the “Regulations.”

Unless otherwise noted, all references herein to a currency are a reference to XXXXXXXXXX dollars.

Our understanding of the Facts, Proposed Transactions, Additional Information, and Purpose of the Proposed Transactions is as described in this letter.

Definitions

The following definitions apply in respect of this advance income tax ruling. Throughout this advance income tax ruling, the singular should be read as plural and vice versa where the circumstances so require:

“ACo” means XXXXXXXXXX;

XXXXXXXXXX;

“ACo Group” means, collectively, ACo and its direct and indirectly owned subsidiaries;

“adjusted cost base” or “ACB” means “adjusted cost base” as that term is defined in section 54;

“APA” means advance pricing arrangement;

“APA Adjustment” means the amounts agreed under the APA Agreement for the APA Taxation Years, being the addition of $XXXXXXXXXX for the taxation year ended XXXXXXXXXX, $XXXXXXXXXX for the taxation year ended XXXXXXXXXX, $XXXXXXXXXX for the taxation year ended XXXXXXXXXX, $XXXXXXXXXX for the taxation year ended XXXXXXXXXX and $XXXXXXXXXX for the taxation year ended XXXXXXXXXX and the reduction of $XXXXXXXXXX for the taxation year ended XXXXXXXXXX, in Canco 1’s income for Canadian income tax purposes and a corresponding reduction from (or addition to) Forco 1’s income for Country A income tax purposes in each of the APA Taxation Years of such amounts, the aggregate of which is equal to $XXXXXXXXXX;

“APA Agreement” means, for the APA Taxation Years, the APA agreement negotiated between the Canadian Competent Authority and the Country A Competent Authority concerning Canco 1 and Forco 1, the terms of which are contained in the appendix attached to the letter dated XXXXXXXXXX from the Country A Competent Authority to Forco 1 and in a letter dated XXXXXXXXXX from the Canadian Competent Authority to Canco 1, agreed upon by Forco 1 with the Country A Competent Authority on XXXXXXXXXX and by Canco 1 and the Canadian Competent Authority on XXXXXXXXXX;

“APA Taxation Years” means the XXXXXXXXXX taxation years of Canco 1 and Forco 1, respectively;

“Auditor” means XXXXXXXXXX and the auditor of ACo, Canco 1 and Forco 1;

“BCA” means the Business Corporations Act XXXXXXXXXX;

“Canadian Competent Authority” means the Minister of National Revenue or the Minister’s authorized representative;

“Canco 1” means XXXXXXXXXX, a corporation formed and existing under the BCA;

“Canco 1 Services Agreement” means the XXXXXXXXXX, dated XXXXXXXXXX, as amended, under which Canco 1 agreed to provide certain XXXXXXXXXX services to the XXXXXXXXXX in exchange for XXXXXXXXXX fees;

“Canco 2” means XXXXXXXXXX, a corporation formed and existing under the BCA;

“Competent Authorities” means the Canadian Competent Authority and the Country A Competent Authority;

“Country A” means XXXXXXXXXX;

“Country A Competent Authority” means the XXXXXXXXXX or their authorized representatives;

“Country A Accounting Standards” means the generally accepted accounting principles in effect in Country A and the International Financial Reporting Standards as applicable to Forco 1 and Forco 2 during the period XXXXXXXXXX;

“Country A Adjustment” means a “correlative adjustment” under XXXXXXXXXX of Country A’s XXXXXXXXXX, namely an arrangement made with a foreign government “in relation to affording relief from double taxation in respect of corporation tax in respect of income and chargeable gains” that provide for an “adjustment of profits”;

“Country A Repayment” means the amount of income taxes that will be repaid under XXXXXXXXXX of Country A’s XXXXXXXXXX, equal to the amount of income taxes that were paid in each of the APA Taxation Years and MAP Taxation Years but were not due in light of the amount of the APA Adjustment and the MAP Adjustment;

“CRA” means the Canada Revenue Agency;

“designated stock exchange” has the meaning assigned by subsection 248(1) and currently includes the Exchange;

“distributable reserves” means the amount of share capital, including retained earnings, that is available for distribution to the shareholders of a corporation in accordance with the laws of Country A;

“earnings” has the meaning assigned by subsection 5907(1) of the Regulations;

“Exchange” means the XXXXXXXXXX Exchange;

“exempt earnings” has the meaning assigned by subsection 5907(1) of the Regulations;

“exempt surplus” has the meaning assigned by subsection 5907(1) of the Regulations;

“FAPI” means foreign accrual property income with the meaning assigned by section 95;

“Fees” means the fees paid by certain of the XXXXXXXXXX to Forco 1 pursuant to the Forco 1 Services Agreement between the XXXXXXXXXX taxation years;

“Forco 1” means XXXXXXXXXX, a corporation formed and existing under the laws of Country A;

“Forco 1 Services Agreement” means the XXXXXXXXXX, dated XXXXXXXXXX, as amended, XXXXXXXXXX, under which Forco 1 agreed to provide XXXXXXXXXX services, XXXXXXXXXX in exchange for the Fees;

“Forco 2” means XXXXXXXXXX, a corporation formerly formed and existing under the laws of Country A;

“GAAR” means the General Anti-Avoidance Rule set out in section 245;

“hybrid surplus” has the meaning assigned by subsection 5907(1) of the Regulations;

“Initial Reassessments” means the CRA issued tax reassessments to Canco 1, starting in XXXXXXXXXX, for the MAP Taxation Years attributing a portion of the Fees paid by the XXXXXXXXXX to Forco 1 as income to Canco 1 under the Canco 1 Services Agreement;

“MAP” means the mutual agreement procedure under XXXXXXXXXX of the Treaty;

“MAP Adjustment” means the amounts agreed under the MAP Settlement for the MAP Taxation Years, being the additions of $XXXXXXXXXX for the taxation year ended XXXXXXXXXX, $XXXXXXXXXX for the taxation year ended XXXXXXXXXX, $XXXXXXXXXX for the taxation year ended XXXXXXXXXX, $XXXXXXXXXX for the taxation year ended XXXXXXXXXX, $XXXXXXXXXX for the taxation year ended XXXXXXXXXX and $XXXXXXXXXX for the taxation year ended XXXXXXXXXX in Canco 1’s income for Canadian income tax purposes and the corresponding reduction from Forco 1’s income for Country A income tax purposes in each of the MAP Taxation Years of such amounts, the aggregate of which is equal to $XXXXXXXXXX;

“MAP Settlement” means, for the MAP Taxation Years, the MAP settlement agreement negotiated between the Canadian Competent Authority and Country A Competent Authority concerning Canco 1 and Forco 1, the terms of which are contained in the letter dated XXXXXXXXXX from the Country A Competent Authority to Forco 1 and in a letter dated XXXXXXXXXX from the Canadian Competent Authority to Canco 1, agreed upon by Forco 1 with the Country A Competent Authority on XXXXXXXXXX and by Canco 1 and the Canadian Competent Authority on XXXXXXXXXX;

“MAP Taxation Years” means the XXXXXXXXXX taxation years of Canco 1 and Forco 1, respectively;

XXXXXXXXXX;

XXXXXXXXXX;

“net earnings” has the meaning assigned by subsection 5907(1) of the Regulations;

XXXXXXXXXX;

“Proposed Transactions” means the transactions described in the Proposed Transactions section of this letter;

“public corporation” has the meaning assigned by subsection 89(1);

“taxable income” has the meaning assigned by subsection 248(1);

“taxable profit” means net income for tax purposes computed in accordance with Country A taxation law;

“taxable surplus” has the meaning assigned by subsection 5907(1) of the Regulations;

“taxation year”, in respect of a foreign affiliate, has the meaning assigned by subsection 95(1);

“taxation year”, in respect of a resident corporation, has the meaning assigned by subsection 249;

“Treaty” means the XXXXXXXXXX, as amended to the date hereof; and

XXXXXXXXXX.

Our understanding of the Facts, the Proposed Transactions, and the Purpose of the Proposed Transactions is as follows:

Facts

ACo Group

1.    ACo is a taxable Canadian corporation and a public corporation that is resident in Canada. It is the parent corporation of the ACo Group.

2.    The ACo Group’s business is to XXXXXXXXXX. The ACo Group has operations in XXXXXXXXXX. Its clients include XXXXXXXXXX.

3.    ACo has a XXXXXXXXXX taxation year-end.

4.    The authorized share capital of ACo includes the class A voting shares and the class B non-voting shares. As of XXXXXXXXXX, the issued and outstanding share capital of ACo consists of approximately XXXXXXXXXX class A voting shares and XXXXXXXXXX Class B non-voting shares. The class B non-voting shares are listed for trading on the Exchange.

5.    Canco 2, a corporation formed and resident in Canada, is a holding company that is wholly-owned by ACo.

6.    Canco 1, a corporation formed and resident in Canada, is an operating company that is wholly-owned by Canco 2. XXXXXXXXXX.

7.    Canco 1 has a XXXXXXXXXX taxation year-end and its taxation centre is the XXXXXXXXXX Taxation Centre and its tax services office is the XXXXXXXXXX Tax Services Office.

8.    Forco 2 was a corporation governed by the laws of Country A.  Forco 2 was a non-resident of Canada and a resident of Country A for the purposes of the Act and Treaty.  Forco 2 was a foreign affiliate and controlled foreign affiliate of ACo for each of the MAP Taxation Years and the APA Taxation Years.  It was wholly owned by ACo until it was wound-up into ACo in accordance with the laws of Country A on XXXXXXXXXX.

9.    Forco 1 is a corporation governed by the laws of Country A.  Forco 1 is a non-resident of Canada and a resident of Country A for the purposes of the Act and the Treaty. Forco 1 is a foreign affiliate and controlled foreign affiliate of ACo for each of the MAP Taxation Years and the APA Taxation Years.  Forco 1 is an operating company that is wholly-owned by ACo.  Until XXXXXXXXXX, it was wholly owned by Forco 2. Forco 1 has a XXXXXXXXXX taxation year-end.  Forco 1 is subject to taxation in Country A under XXXXXXXXXX of XXXXXXXXXX which provides that:

XXXXXXXXXX

10.   Forco 1 is regulated by the XXXXXXXXXX of Country A and provides a range of XXXXXXXXXX services to certain of the XXXXXXXXXX and to third parties.

11.   ACo, Forco 1 and Canco 1 do not deal at arm’s length with each other for purposes of the Act.

Intercompany Services and Dividends Paid

12.   XXXXXXXXXX.

13.   Forco 1 entered into the Forco 1 Services Agreement with certain XXXXXXXXXX. Forco 1 is the only provider of services under the Forco 1 Services Agreement.

14.   Canco 1 entered into the Canco 1 Services Agreement with the XXXXXXXXXX. Canco 1 is the only provider of services under the Canco 1 Services Agreement.

15.   The Fees earned by Forco 1 under the Forco 1 Services Agreement in the MAP Taxation Years and the APA Taxation Years were income from an active business carried on by Forco 1 in Country A. See also paragraph 24.

16.   During the MAP Taxation Years and the APA Taxation Years, Forco 1 paid regular dividends to Forco 2 for taxation years preceding its wind-up and to ACo for subsequent taxation years. Substantially all of Forco 1’s income earned in that period (net of Country A corporate income taxes paid) was paid out as dividends.

17.   At the time each dividend was declared and paid by Forco 1, management determined that there were sufficient distributable reserves, taking into account the Fees net of applicable Country A income taxes, to lawfully pay the dividends.

18.   At the end of the last of the APA Taxation Years, Forco 1’s exempt surplus balance was nil, its hybrid surplus balance was nil and its taxable surplus balance was nil.  In addition, as of the foregoing date, Forco 1’s exempt deficit balance was nil, its hybrid deficit was nil and its taxable deficit was nil.

Reassessments, MAP and APA

19.   In XXXXXXXXXX, Canco 1 and Forco 1 submitted a bilateral APA request to the Competent Authorities to establish the appropriate transfer pricing methodology for the APA Taxation Years. Canco 1 and Forco 1 were accepted into the bilateral APA program.

20.   The CRA issued the Initial Reassessments to Canco 1 for the MAP Taxation Years, including a portion of the Fees paid by the XXXXXXXXXX to Forco 1 in the income of Canco 1. The total amount added to Canco 1’s income as a result of the Initial Reassessments was approximately $XXXXXXXXXX.

21.   The Initial Reassessments were issued under paragraph 247(2)(a) on the basis that the Fees differed from those that would have been negotiated between persons dealing at arm’s length.  Specifically, it was asserted that (i) by entering into the Canco 1 Services Agreement, Canco 1 had implicitly agreed to a reduction of its own fees such that the Fees paid to Forco 1 were higher than they should have been from a transfer pricing perspective and (ii) a portion of the Fees should therefore have been earned by Canco 1.

22.   Canco 1 duly and timely objected to the Initial Reassessments.

23.   Starting in XXXXXXXXXX, Canco 1 submitted a series of requests to the Competent Authorities under the MAP for relief from double-taxation with respect to the MAP Taxation Years.  Canco 1’s objections were held in abeyance pending the resolution of the MAP.  See also Paragraph 27.

24.   In a letter dated XXXXXXXXXX, the CRA proposed to reassess ACo in respect of FAPI in connection with the Fees earned by Forco 1 for the XXXXXXXXXX taxation years.  However, in a letter dated XXXXXXXXXX, the CRA advised that it had withdrawn the proposal outlined in the first referenced letter.

25.   The MAP Settlement settled the Initial Reassessments with the MAP Adjustment.

26.   Penalties for the MAP Taxation Years under subsection 247(3) were not addressed under the MAP Settlement.  Canco 1 was previously assessed penalties under subsection 247(3) and Canco 1 made a submission to the CRA in XXXXXXXXXX to have the penalties withdrawn.

27.   The XXXXXXXXXX letter MAP Settlement stated, in part, the following:

a)    “The settlement of the [MAP Adjustment], including the recording of a liability or receivable, is not required.  […]  Although not required, any settlement of the [MAP Adjustment] would be free of any withholding tax”.

b)    “No secondary adjustment shall be made in respect of the [MAP Adjustment] to i) the income of [Canco 1] or [Forco 1] or to ii) create a loan, deemed trust or other obligation between [Canco 1] and [Forco 1]”.

c)    “[Canco 1] waives any right of objection or appeal [to the MAP Taxation Years] in respect of the services provided by [Forco 1]”.

28.   The Competent Authorities agreed upon the APA Agreement with the APA Adjustment.

29.   Under the APA Agreement, Canco 1 will not be assessed penalties for the APA Taxation Years under subsection 247(3).

30.   The XXXXXXXXXX APA Agreement from the Canadian Competent Authority stated, in part, the following:

a)    “the settlement of the [APA Adjustment], including the recording of a liability or receivable, is not required.  […]  Although not required, Canco 1 and Forco 1 may settle compensating adjustments by any method which they deem appropriate.   […]  In addition, any payment of a compensating adjustment will be made free of any withholding tax as the underlying Covered Transaction would not have been subject to withholding tax”.

b)    “No secondary adjustment will be made in respect of the [APA Adjustments] to i) the income of [ACo] or of [Forco 1] or to ii) create a loan, deemed trust or other obligation between Forco 1 and Canco 1”.

c)    Canco 1 waived any right to object or appeal in respect of the APA Adjustment for the APA Taxation Years.

Country A Reassessment and Corporate Law

31.   The APA Adjustment and the MAP Adjustment for each MAP Taxation Year and APA Taxation Year are a Country A Adjustment and as such, reassessments by the Country A tax authority will reduce Forco 1’s income and Country A will repay to Forco 1 the amount of the Country A Repayment.

32.   As a result of the reassessments, Forco 1 expects to receive an aggregate income tax refund from the Country A tax authority of approximately $XXXXXXXXXX for the MAP Taxation Years and the APA Taxation Years.

33.   Forco 1 did not and will not make any payment to Canco 1 in respect of the addition of the MAP Adjustment and the APA Adjustment in the income of Canco 1 for Canadian tax purposes.

34.   Under Country A law, transfer pricing adjustments (the MAP Adjustment and the APA Adjustment) and corresponding reassessments by the Country A tax authority do not alter the legal right of Forco 1 to the Fees earned pursuant to the Services Agreement.

35.   The Country A Accounting Standards do not require any retroactive accounting restatements of Forco 1’s original financial statements with respect to the MAP Taxation Years and the APA Taxation Years.

Proposed Transactions

36.   Forco 1 will declare a dividend equal to $XXXXXXXXXX payable to ACo.

37.   Forco 1 will pay the dividend equal to $XXXXXXXXXX to ACo.

Additional Information

38.   Forco 1 will not make any election under subsection 5901(2) of the Regulations to reorder its surplus distributions.

39.   Forco 1 estimates that it will have a net loss from an active business for each of its XXXXXXXXXX taxation years in the amount of approximately XXXXXXXXXX per year.

40.   At the time Forco 1 determines it is probable that it will become eligible to receive the Country A Repayment, Forco 1 will, under Country A Accounting Standards, add the entire amount recovered to its distributable reserves/retained earnings, and will report it as such in its financial statements for the year in which such determination is made and will record taxes recoverable and an increase in its distributable reserves/retained earnings.

Purpose of the Proposed Transactions

Forco 1 will declare and pay the dividend described in paragraphs 36 and 37 in order to fulfill its obligations under the ACo Group’s current dividend policy to pay out substantially all of its distributable reserves/retained earnings.

Rulings Given

Provided that the preceding statements constitute a complete and accurate disclosure of all the relevant Facts, Proposed Transactions, Additional Information, and the Purpose of the Proposed Transactions, and provided further that the Proposed Transactions are completed in the manner described above, and there are no other transactions that may be relevant to the ruling given, we rule as follows:

A.    The earnings of Forco 1, as determined under subparagraph (a)(i) of the definition of “earnings” in subsection 5907(1) of the Regulations, for each MAP Taxation Year and APA Taxation Year, is equal to its income or profit from an active business as computed in accordance with the income tax law of Country A, which reflects adjustments for each such taxation year to account for the MAP Adjustment and the APA Adjustment pertaining to that taxation year.

B.    The amount of the MAP Adjustment and APA Adjustment that is excluded from the computation of income or profit from an active business pursuant to the income tax law of Country A for each of the MAP Taxation Years and the APA Taxation Years is added to the earnings of Forco 1 for each such taxation year pursuant to paragraph 5907(2)(f) of the Regulations.

C.    Upon receipt of the Country A reassessment reducing income reflecting the MAP Adjustment and APA Adjustment and establishing the amount of taxes previously paid in respect of such income that are not payable in light of these adjustments, the “net earnings” of Forco 1, as defined in paragraph 5907(1)(a) of the Regulations, for each of the MAP Taxation Years and the APA Taxation Years, will be increased by an amount equal to the amount of such income taxes that were paid for each such taxation year to the government of Country A but are not payable in light of the amount of the APA Adjustment and the MAP Adjustment pertaining to that taxation year.

Upon the payment of Country A income taxes owing as a result of the Country A reassessment increasing income reflecting the APA Adjustment and establishing the amount of taxes owing in respect of such income, the “net earnings” of Forco 1, as defined in paragraph 5907(1)(a) of the Regulations, for the relevant APA Taxation Year, will be decreased by an amount equal to the amount of such income taxes that is paid for such taxation year to the government of Country A as a result of the APA Adjustment pertaining to that taxation year.

Comments

The above Rulings are given subject to the limitations and qualifications set out in Information Circular 70-6R7 dated April 22, 2016 and are binding on the CRA provided that the Proposed Transactions are undertaken within the later of six months of the date of this letter and 30 days after receipt of the Country A Repayment.

Nothing in this letter should be construed as implying that the Canada Revenue Agency has agreed to, reviewed or has made any determination in respect of any tax consequences relating to the Facts, Proposed Transactions, and Additional Information described herein other than those specifically described in the Rulings given above and in particular, without limiting the generality of the foregoing, in respect of:

a)    any transaction of Forco 1 undertaken during the MAP Taxation Years and the APA Taxation Years;

b)    the character of the income earned by Forco 1 during the MAP Taxation Years the and APA Taxation Years;

c)    the ACB of the shares of Forco 1 to ACo at any time during the MAP Taxation Years and the APA Taxation Years;

d)    the computation of the earnings or surplus balances of Forco 1 in respect of ACo during the MAP Taxation Years and the APA Taxation Years; and

e)    the computation of taxable income under the income tax laws of Country A as a result of the reassessment of taxable income and income taxes payable arising from the MAP Adjustment and the APA Adjustment.

An invoice for our fees in connection with this ruling will be forwarded to you under separate cover.

Yours truly,

XXXXXXXXXX
Manager
for Division Director
International Division
Income Tax Rulings Directorate

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