Owens Corning Canada Holdings ULC is a Canadian unlimited liability company with a controlled foreign affiliate, OC NL Invest Cooperatief UA (“Coop2”), which licenced intellectual property from a related non-resident entity, Owens Corning Holdings 5 CV (“IP Holder”). Coop2 sub-licenced this intellectual property to entities within the Owens Corning group and third parties, earning passive income. The licence agreement between Coop2 and IP Holder provided that the royalty would be calculated based on an arm’s length standard, but no payments were actually made or accrued. When Owens Corning Canada filed its tax returns for the 2017 and 2018 taxation years, it calculated its foreign accrual property income (“FAPI” — a concept under Canada’s Income Tax Act that attributes certain passive income earned by controlled foreign affiliates to the Canadian resident shareholder for immediate taxation) from Coop2 and deducted over $3,000,000 per year in royalty payments. The Minister of National Revenue reassessed the company to deny the deductions. Owens Corning Canada appealed, seeking a downward transfer pricing adjustment under subsection 247(2) of the Income Tax Act.
The Crown brought a motion to quash the appeal, arguing that the Tax Court of Canada lacked jurisdiction to order downward transfer pricing adjustments. Under subsection 247(10) of the Income Tax Act, a taxpayer may only obtain a downward transfer pricing adjustment if the Minister is of the opinion that the circumstances make it appropriate. The Supreme Court of Canada’s decision in Dow Chemical Canada ULC v. The King and the Federal Court of Appeal’s decision in Meglobal Canada ULC v. The King had clearly established that downward transfer pricing adjustments are a discretionary decision of the Minister, placing them outside the Tax Court’s jurisdiction.
Owens Corning Canada accepted the Court’s lack of jurisdiction over downward adjustments generally, but argued it was not seeking such an adjustment — rather, it was simply seeking to properly calculate its FAPI. The company relied on paragraph 95(2)(f) of the Income Tax Act, which deems a foreign affiliate to be resident in Canada for purposes of computing property income, to bring the transfer pricing provisions into play. It further argued that the phrase “except to the extent that the context otherwise requires” in paragraph 95(2)(f) precluded the application of subsection 247(10), contending that it would be inappropriate to require non-residents (Coop2 and IP Holder) to obtain the Minister’s permission. Owens Corning Canada also argued that because no formal system existed to obtain the Minister’s opinion under subsection 247(10) in the FAPI context, the opinion was not required.
Judgment
The Tax Court of Canada granted the Crown’s motion and quashed the appeals for the 2017 and 2018 taxation years.
The court rejected Owens Corning Canada’s attempted recharacterisation of its claim. The Court held that the FAPI provisions do not tax the foreign affiliate itself but rather tax the Canadian resident shareholder on the affiliate’s income. While the computation required Owens Corning Canada to calculate Coop2’s income, the obligation was on Owens Corning Canada, not on the foreign affiliate. Therefore, if Owens Corning Canada wished to use subsection 247(2) to make a downward transfer pricing adjustment to its FAPI, it was required to apply to the Minister for permission, facing the same restrictions on downward transfer pricing adjustments as any Canadian resident. The Court also dismissed the argument based on the absence of a formal application process, holding that the lack of an established mechanism for obtaining the Minister’s opinion in the FAPI context did not allow the Court to fill the vacuum by seizing jurisdiction. The Court noted that Owens Corning Canada had not yet applied to the Minister for the exercise of discretion and that, if the Minister were to refuse, the company’s recourse would be to the Federal Court. Costs were awarded to the Respondent.
This appears to be a classic asymmetry issue. Claiming deduction for hypothetical royalties in Canada and presumably without taxing it in the hands of the IP Owner. Theoretically, if another territory were to impose an upward transfer pricing adjustment on the IP Owner, the group might be able to seek a corresponding adjustment in Canada through MAP under the relevant tax treaty. The tax effect of $3m does not seem to be material to Owen Corning, so maybe that’s not an option considering the time it takes to go through MAP.