Background

On occasion, the adage “the best defence is a good offence” aptly applies in tax litigation, as a taxpayer may defend against an (income) adjustment by claiming an extra deduction to offset the adjustment. This is possible because the adjustments are typically income adjustments and income is a net concept, therefore allowing for set-offs. In the context of transfer pricing, however, the situation is different. Subsection 247(10) of the Income Tax Act (all legislative references in this article are references to this Act) precludes a downward transfer pricing adjustment, unless in the opinion of the Minister of National Revenue (“Minister”), it would be appropriate in the circumstances. This is because a transfer pricing adjustment is transaction-based.

Context

Dow Canada is a Canadian resident company owned by The Dow Chemical Company, a US corporation. In 2006 and 2007, Dow Canada paid interest to a Swiss affiliate (“Dow Eur”), pursuant to a revolving loan. In 2011, the Minister assessed Dow Canada’s 2006 and 2007 taxation years, making an (upward) transfer pricing adjustment increasing Dow Canada’s income related to services it also provided to Dow Eur. The Minister later advised that an initial downward transfer pricing adjustment proposal to increase the interest expense taken with respect to the loan was off the table for Dow Canada’s 2006 taxation year, because of the limitation period in the Canada-Switzerland Tax Treaty.  What followed was a reassessment that did not increase Dow Canada’s interest expense, prompting Dow Canada to ask the Minister to make a downward transfer pricing adjustment for its 2006 taxation year. The Minister refused, exercising its discretion under subsection 247(10) to deny the request on the basis that the downward adjustment was prohibited by the Canada-Switzerland Tax Treaty and that it would result in double non-taxation. Finally, the Minister reassessed Dow Canada’s 2006 taxation year without making any downward interest adjustment. Dow Canada appealed that reassessment to the TCC, eventually giving rise to the jurisdictional debate. 

Tax Court of Canada Decision

Dow Canada’s main position was that the Minister’s decision under subsection 247(10) goes to the correctness of the assessment and so, is properly the subject of an appeal to the TCC. Conversely, the government’s main position was that any review of the Minister’s decision to not make a downward adjustment is beyond the jurisdiction of the TCC and accordingly must be challenged through judicial review at the Federal Court.

The TCC rejected Dow Canada’s argument that subsection 247(11), which incorporates rights to object to and appeal assessments, provides for a separate right of appeal from the Minister’s decision to deny a downward transfer pricing adjustment to the TCC. The TCC also conducted a detailed review of jurisprudence where the Minister made certain discretionary decisions that directly impacted taxpayers’ income.  Following that review, the TCC concluded that on an appeal of an assessment resulting from the Minister’s decision under subsection 247(10), the TCC is both permitted and required to review the manner in which the Minister came to the decision (i.e., refusing to make a downward transfer pricing adjustment). In further support of its conclusion that the TCC may review discretionary decisions made by the Minister, the TCC compared the appeals scheme under a quasi-tax statute, the Employment Insurance Act, and related jurisprudence. 

The crux of the TCC’s holding was that the Minister’s decision under subsection 247(10) is an essential component of the assessment, goes to the correctness of the assessment, and accordingly may be reviewed by the TCC under its jurisdiction to determine the correctness of the assessment. Where a taxpayer claims and establishes a downward transfer pricing adjustment, the determination under subsection 247(10) must be made before a correct assessment can be issued. If the power under subsection 247(10) is improperly exercised, then the resulting assessment is not correct in law—just like a domino effect.

Federal Court of Appeal Decision

Under general principles, judicial review is unavailable if a statutory appeal is possible. There was consensus that subsection 247(11) does not provide for a separate right of appeal from the Minister’s decision under subsection 247(10). Therefore, the Federal Court is not barred, at the outset, from reviewing that decision. 

Unpersuaded that the jurisprudence reviewed by the TCC supported its finding that the Minister’s decision under subsection 247(10)  is within its jurisdiction, the Federal Court of Appeal (“FCA”) said that in its view, the resolution of the jurisdictional question turned on the different remedies that may be granted by the TCC and the Federal Court. On that point, the FCA expressed concerns that the remedies available to the TCC may be inadequate to achieve the result sought by Dow Canada: a reassessment based on a reduction in income that reflects the downward adjustment. Unless the Minister’s opinion under subsection 247(10)  is changed to allow a downward adjustment, the reassessment which does not reflect the downward adjustment is correct, and cannot be varied or set aside by the TCC when dealing with an appeal from the resulting reassessment.  According to the FCA, the TCC cannot effect such a change, since it lacks power to vary the Minister’s opinion. The FCA emphasized that the TCC’s remedies apply only to the assessment and not the process that results in the assessment. While the opinion rendered under subsection 247(10) directly impacts an assessment, the opinion is not itself an assessment, but rather merely a part of the process. Essentially, the consequence of this distinction is that on an appeal of the reassessment, the TCC is unable to help Dow Canada overcome the obstacle of an unfavourable decision under subsection 247(10).

The FCA ultimately concluded that since the Federal Court, not the TCC, has power to quash an opinion rendered under subsection 247(10), and in rare cases, substitute its opinion for the opinion of the Minister, the validity of the opinion is more properly a matter for judicial review in the Federal Court.

Implications of the Federal Court of Appeal Judgment 

The FCA’s conclusion that the Minister’s decision under subsection 247(10) is outside the exclusive jurisdiction of the TCC leads to the bifurcation of a transfer pricing dispute, where a taxpayer wants to appeal an assessment on the basis that the Minister’s decision to deny a downward adjustment was improper. Indeed, the FCA acknowledged that Dow Canada will likely need to go before both the Federal Court and the TCC to succeed.  A silver lining for tax litigators but not for companies.

Ideally, on an appeal of an assessment before the TCC, a taxpayer would benefit from having the TCC simultaneously consider all issues going to the correctness of the assessment. As the TCC emphasized, the Minister’s subsection 247(10) decision and the resulting assessment are interconnected, as the former goes to the correctness of the latter, and the decision should be reviewable under the TCC’s jurisdiction to determine the correctness of the assessment. However, the reality is that the law as it stands requires taxpayers to challenge the denial of a downward transfer pricing adjustment through judicial review in the Federal Court, as a starting point. This will require the aggrieved taxpayer to seek judicial review in the Federal Court within 30 days of the Minister's decision to refuse a downward adjustment and follow the judicial review procedure under the Federal Court Rules.

The decisions are remarkably thorough and well-reasoned and contrast the opposite judicial attitudes of a specialized tax court of first instance to that of a multi-disciplinary appellate and review court. It will be interesting to see whether Dow Canada will seek leave to appeal to the Supreme Court of Canada, which is granted only on the grounds of national importance.