In the case of General Electric Capital, Canada, the issue was if a 1% guarantee fee paid by General Electric Capital Canada Inc. to its AAA-rated US parent company satisfied the arm’s length test.
The Canadian tax administration argued that implicit support resulted in General Electric Canada having a AAA credit rating, so that the guarantee provided by the US parent had no value.
Taxpayer argued that the 1% guarantee fee did not exceed arm’s length pricing and that implicit support from the US parent should be ignored since it stemmed from the non-arm’s length relationship.
The Tax Court agreed with the tax administration that implicit support should be taken into account and applied a “yield approach,” comparing the interest rate the Canadian company would have paid with and without the guarantee. The Tax Court found that credit rating of the Canadian company – with implicit support but without the guarantee – was at most BBB-/BB+ and the 1% guarantee was arm’s length.
The Federal Court of Appeal approved of both the Tax Court’s yield approach and its conclusion that the guarantee fee did not exceed an arm’s length price. On the issue of implicit support the Court concluded that under the arm´s length principle implicit support had to be taken into account . Determining arm’s length pricing “involves taking into account all the circumstances which bear on the price whether they arise from the relationship or otherwise.” Hence, Circumstances that are themselves inherently non-arm’s length in nature must also be considered.
The relevant question is what an arm’s length guarantor would charge to provide a guarantee to a comparable subsidiary of a comparable AAA-rated US parent Company. Comparing prices of loans without regard to implicit support from the US parent, fails to recognize all of the relevant economic circumstances of the controlled transaction.