Canada: Migrating IP Offshore Within A Transfer Pricing Setting

Last Updated: October 2 2007

Article by Dale C. Hill and Santino Di Libero1

I. Introduction

If a multinational corporation had the luxury of perfect hindsight, it would optimize its global positioning and operational efficiencies by migrating intangible assets prior to those assets proving valuable. Most companies, however, do not have such luxury, and the decision to migrate assets often comes well after their value is realized. In light of this, it comes with little surprise that discussions regarding government crackdowns on tax havens have occurred recently as more and more multinational organizations move profits offshore to low tax jurisdictions.

The CRA and other tax authorities have stepped up their enforcement activities related to various industries that employ valuable intellectual property, including pharmaceuticals. The CRA announced in 2005 that it set up eleven centers of expertise to deal with aggressive international tax planning. These centres are located in regional Tax Services Offices across Canada, and they bring together international tax auditors and tax avoidance officers. One of the priorities of the centers will be to to develop new ways to address aggressive international transactions. It seems that transfer pricing transactions, and specifically the migration of IP, are a major target in CRA's audit compliance reviews.

With increased resources available to it, the CRA is combining both its rapidly improving knowledge of transfer pricing disciplines, with improved legislative powers, to raise transfer pricing adjustments within the pharmaceutical industry.

From a tax perspective, any financial planning that involves moving profits offshore by multinational organizations can be justifiable if the corresponding functions, assets and risks borne to earn these profits are also shifted offshore, and where the appropriate buy in payments have been made. The world economy has become increasingly globalized, and the need to minimize after-tax profits is not only advantageous to improving corporate profits, but is also necessary in order to remain competitive. While implementing such a framework is a long and complex process, it can result in material tax savings.

II. Recent Transfer Pricing Issues Related to Large Pharmaceutical Companies and IP

While there are many clear benefits to migrating intangibles, such a strategy poses risks, including the potential for significant transfer pricing adjustments. Ideally, intangibles should be migrated when they do not possess considerable economic value. However, as stated earlier, companies often do not have the benefit of hindsight and often decide to migrate after the intangibles prove valuable.

During transfer pricing audits, government authorities have used existing legislation (i.e. section 247(2)(b) of the Canada Income Tax Act) to re-characterize related party transactions after settlement negotiations have broken down, resulting in transfer pricing adjustments.

An application of the government's power to re-characterize a particular transaction has been seen in the recent transfer pricing dispute between the CRA and Merck Frosst Canada ("Merck"). The CRA is examining the tax returns of Merck from 1998 through 2004, and has reassessed Merck for "adjustments related to certain intercompany pricing matters". On October 10, 2006, the CRA issued a notice of reassessment related to various intercompany transactions totalling US$1.4 Billion plus, US$360 Million in interest. While all details of the case are not known, it has been disclosed in various media sources that the adjustments relate to Merck's patent for its asthma drug Singular. The drug, developed in Quebec, generated sales of US$950 Million in the second quarter of 2006. The patent was later transferred to Barbados. Given the considerable size of the adjustment, it can be surmised that the negotiations between the CRA and Merck have not resulted in an acceptable resolution. Consequently, the CRA has used its ability to apply existing legislation to re-characterize the transaction as if the transaction did not occur, thus raising the corresponding adjustment.

While the dispute with Merck is yet to be resolved, the financial resources required to handle such a dispute can be daunting. Merck could be required to post a deposit of up to half of the tax and interest assessed.

III. Opportunities for Migrating Intangibles: Textbook Application

Tax authorities around the world have begun to target structures which migrate profits offshore. As a result, multinational companies need to ensure that their documentation is sufficient to support the migration of valuable intangibles, and the profits they drive.

Three methods commonly used to migrate these intangibles assets include:

(i) cost sharing agreements;
(ii) buy-in payments; and
(iii) sale of intangibles.
Cost Sharing Agreements ("CSA")

CSAs are one of the most effective ways to migrate intangibles. A CSA is an agreement between two parties, which defines the contributions each party will make in terms of costs expended, and the associated benefits that will be returned to the parties for such an investment. In order for a CSA to be effective, it must:

(i) make business and economic sense;
(ii) include upfront and well-documented terms;
(iii) indicate costs incurred by each party relative to the reasonability of expected profits; and
(iv) if providing for entry, exit, or termination of a CSA, provisions must involve arm's length prices.

Failure on the part of companies to draft effective CSAs serves only to increase audit risk. In this respect, great care must be taken to ensure that CSAs make both economic and business sense.

CSAs are often found in industries that require substantial research and development ("R&D") activities, such as the pharmaceutical industry. In such an industry, some of the costs associated with performing the R&D activities are performed in low tax jurisdictions. Given that these related parties pay for a portion of the R&D, they are entitled to exploit an interest in the intellectual property that was developed. As a result, no royalty on the CSA will be required to be paid.

Buy-in/Buy-out

Buy-in/buy-out payments are another way to migrate intangible income offshore. Buy-in payments require a party in a related party setting to "buy-in" to a CSA, or "buy-out" of one. In order to do so, the buy-in/buy-out payments must be payments that represent arm's length prices. Buy-in options are very valuable given that they provide many opportunities. They also involve associated risks, which must be reflected in the purchase price. Subsidiaries must pay fair market value to buy-in. Failure to do so will increase the firm's audit risk for an unfavourable audit.

Sale of Intangibles

The final approach regarding the migration of intangibles is through the sale of intangibles. Intangibles are a large source of profits, and selling them to offshore affiliates will help build support for the argument that profits that are generated from these assets should be taxed in these offshore jurisdictions. It is important, as in the other two cases above, to ensure that this is done at arm's length prices. Determining the arm's length sale of intangibles is very complicated. The most common way of determining the price at which this should be transacted involves the Comparable Uncontrolled Price ("CUP") methodology. This requires that we find external comparables that involve the sale of very similar intangibles, which is often difficult to achieve.

IV. Conclusion

The migration of intangibles is an acceptable tool in an effort to maximize after-tax profits. However, doing so normally requires the migration of functions, assets and risks. One should be cautioned that with respect to intangibles that have proven valuable, and are subsequently migrated, taxing authorities will certainly be on the alert to scrutinize the transactions, as the Merck case has shown. It is imperative that any strategic decision to transfer intangibles be supported by comprehensive transfer pricing documentation that incorporates as much evidence supporting an arm's length price as possible.

Footnote

1. Santino Di Libero, Senior Director, Transfer Pricing and Competent Authority Group, Gowling Lafleur Henderson, LLP, was formerly a senior transfer pricing analyst and team leader at the Montreal Tax Services Office of the Canada Revenue Agency. He possesses 30 years of audit experience and approximately 20 years experience in the international tax field.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Events from this Firm
7 Nov 2019, Seminar, Birmingham, UK

Providing content specifically tailored to the needs of GCs and Heads of Legal working in government organisations and their affiliates.

14 Nov 2019, Seminar, London, UK

Providing content specifically tailored to the needs of GCs and Heads of Legal working in government organisations and their affiliates.

 
In association with
Related Topics
 
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Mondaq Free Registration
Gain access to Mondaq global archive of over 375,000 articles covering 200 countries with a personalised News Alert and automatic login on this device.
Mondaq News Alert (some suggested topics and region)
Select Topics
Registration (please scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions