A restructuring contract dated 16 June 2003 was entered between NORTEL NETWORKS LIMITED and CODISCO INVESTMENTS LLC and promissory notes were issued by OPERADORA UNEFÓN, S.A. de C.V.
Following an audit, an assessment was issued by the tax authorities, where the transaction was recharacterised and priced on an aggregatet basis taking into account the totality of the arrangement.
Judgement of the Court
The court upheld the assessment.
According to the court, when the tax authorities carries out an audit of transactions between related parties, it must do so based on the structure and contractual agreements as determined by the associated enterprises. However, the general rule provides for two exceptions where the tax authorities may disregard the form and recharacterise the transactions for tax purposes.
- The first exception occurs when the economic substance of the transaction differs from its form.
- The second exception occurs when, although the form and substance of the transaction coincide, the arrangements relating to the transaction, taken as a whole, differ from those that would have been entered into by independent companies acting in a commercially rational manner and their actual structuring prevents the tax administration from determining the appropriate transfer price.
Where controlled transactions fall under these two exceptions, tax authorities may determine the taxable income and deductions based on the economic substance of the underlying transaction actually carried out between the parties.
This standard is based on the 1995 Transfer Pricing Guidelines, CHAPTER I, paragraph 1.37.
Furthermore, according to paragraphs 1.42 to 1.44 the arm’s length principle must take into consideration that separate transactions can be so closely linked that they cannot be valued on a separate basis.
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