CRA assessed a Canadian subsidiary (Canco 1) in a Canadian multinational group under s. 247(2) on the basis that the fees earned by a sister company (Forco 1) resident in Country A from a customer were too high from a transfer-pricing perspective and the fees earned by Canco 1 under a services contract as part of the same business arrangements were correlatively too low. After negotiations between the competent authorities for Canada and Country A, it was agreed that Canco 1 would not appeal this assessment, and the income of Forco 1 (which was from an active business) would be reduced by assessment by the Country A taxing authority, thereby generating income tax refunds for those years. It was agreed that there would be no adjustment to the actual fees charged to the (apparently arm’s length) customer(s) and that there would be no secondary adjustments.
CRA ruled that these downward adjustments to the business income of Forco 1 reduced its (exempt) earnings as determined under s. (a)(i) of the definition of “earnings” in Reg. 5907(1), i.e., its earnings as computed in accordance with the Country A income tax law – but that such adjustments were to be added to its earnings pursuant to Reg. 5907(2)(f).
CRA also ruled that upon receipt of the Country A reassessment reflecting such downward income adjustments for the relevant years, the “net earnings” of Forco 1 for those years as defined in Reg. 5907(1)(a) would be increased by the amount of income taxes that had been correspondingly overpaid.