The Queen vs. General Electric Capital Canada Inc (Court of Appeal, Canada)

Transfer Pricing: Despite “Implicit support” by holding company, subsidiary entitled to pay holding company at arms’ length for “explicit support”

The assessee, a wholly-owned subsidiary of General Electric Capital US (GECUS), was in the business of providing financial services and took loans for this purpose in the form of commercial paper and unsecured debentures. Between 1988 and 1995, GECUS provided to the assessee, at no cost, an explicit guarantee for its debt issuances. From 1996, GECUS began charging a fee equal to 1% of the face amount of the assessee’s debt issuances for that same guarantee which amounted to about $135.4 million. The assessee’s claim for deduction of the fee was denied by the tax department u/s 69(2)/247(2) (transfer pricing provisions) on the ground that as there was “implicit support” by GECUS to the assessee, the payment of the guarantee fee was “superfluous” and not at arms’ length. This was reversed by the Tax Court on the basis that by the explicit guarantee from the holding company, the assessee had a better rating and had to pay lower interest and received a benefit which was valued at 1.83%. As the fee paid for the benefit was only 1%, it was at arms’ length. On appeal by the department, HELD dismissing the appeal:

(i) In determining the arms length price, all economically relevant factors (including the “implicit support” that the subsidiary enjoys from the holding company) have to be considered. The explicit guarantee by the holding company also has a value to the subsidiary (Para 1.6 of the OECD Commentary on Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations referred). The question is how much an arm’s length party, benefiting from the implicit guarantee would be willing to pay for the explicit guarantee;

(ii) The “yield method” can be adopted which requires a comparison between the credit rating which an arm’s length party, in the same circumstances as the assessee, would have obtained and the credit rating which would have been obtained without the explicit guarantee. On facts, it was shown that the assessee would have enjoyed a lower credit rating without the explicit guarantee from the holding company and would have had to pay a higher interest than it did with the explicit guarantee. The incremental cost that the assessee would have had to pay if it did not have the explicit guarantee was valued at 1.83% and so the guarantee fee was at arms length.