The court decided that the CRA was entitled to use powers under subsection 231.6 of the Income Tax Act to request information from Bahamas corporations that provided services to Canadian Soft-Moc.
“I think this result may encourage the CRA to use such information requests in other transfer pricing cases,” said Mark Meredith, of KPMG.
“Given the CRA’s increased focus on transfer pricing for other reasons, we will probably see quite a lot more,” he added.
Foreign-based information requirement
In 2005 and 2006, Canadian resident Soft-Moc made service payments to four related companies in the Bahamas.
These companies, and their Bahamian resident shareholder, owned 90% of the common shares of Soft-Moc.
The CRA carried out a transfer pricing audit of Soft-Moc in 2009, which included examining whether the service payments made to the Bahamas companies were at arm’s-length.
The CRA issued Soft-Moc with a formal notice of requirement for foreign-based information – a power bestowed on the CRA by subsection 231.6(2) of the Canadian Income Tax Act.
The information requirement asked for details of the Bahamas companies’ financial statements, minute books, services provided, employee data, as well as interactions between the Bahamas companies and various independent agents and service providers.
The Bahamas companies refused to provide all of the information requested on the grounds that the information:
· Did not exist;
· Was confidential and proprietary; and
· Would damage the competitive advantage of the respective Bahamas company.
Soft-Moc applied for judicial review of the decision to issue the requirement.
Federal Court ruling and implications
The Federal Court dismissed Soft-Moc’s request, saying the information requirement was necessary for the CRA to determine the arm’s-length nature of the service payments and the request did not go beyond the purpose of the Income Tax Act.
The court noted the CRA has broad statutory powers to collect information and said the threshold for determining whether the information requested is relevant and reasonable is low.
The Income Tax Act explicitly empowers the court to restrict the scope of the information requirement as appropriate in the circumstances, or to set it aside entirely if it is unreasonable.
But Meredith said it appears from this and other cases – such as Saipem Luxembourg – that the courts are willing to give substantial latitude to the CRA in this area.
In Soft-Moc, it appears the court was influenced by the close ownership connection of the parties involved, though it could be possible for the CRA to issue a foreign-based information request for information on dealings between the non-resident and third parties since such information could be relevant to a transfer pricing analysis.
Soft-Moc produced little credible evidence of any real harm that would arise for any party because of disclosure to the CRA.
Meredith said if the applicant in another case could credibly demonstrate such harm, a different result could well be obtained.
“The judge also seemed to place substantial reliance on a common law obligation of good faith on the minister, but did not seem to expressly consider whether that obligation was being complied with in this case,” said Meredith.
“That said, in this case there does not appear to have been any lack of good faith evidence or argument presented by the applicant but in another case, a taxpayer might try to make such an assertion,” he added.
Canada does have a tax information exchange agreement (TIEA) with the Bahamas which entered into force in 2011, meaning it would not have been available to the CRA for information relating to 2005 and 2006.
However, the court also said it is not for the taxpayer to say that information could be ascertained by other means, which suggests even where a relevant TIEA is in force, the CRA could still elect to use a foreign-based information request to gain information instead of going through the terms of the TIEA.
Once a foreign-based information requirement notice is issued for domestically available information, taxpayers can be punished through contempt of court if they fail to comply.
Charles Thériault, of PwC, said failure to comply with requirements for foreign-based information can lead to all such requested information being excluded from use by the taxpayer in future court proceedings on tax.
“Taxpayers usually find that dealing with formal requirements under a transfer pricing audit is more risky, time-consuming and administratively burdensome than managing the audit relationship so as to receive only the more conventional form of tax audit queries,” said Thériault.
