The McKesson case: Key transfer pricing principles in the context of debt factoring

Dr Danny Beeton and Dr Rupert Macey-Dare, Freshfields Bruckhaus Deringer, London

Danny Beeton is Head of Transfer Pricing Economics;
Rupert Macey-Dare is a member of the Dispute Resolution and Transfer Pricing practice

The trial of McKesson Canada Corporation v. The Queen commenced in the Tax Court of Canada in Toronto on October 17, 2011 and is expected to take six to seven weeks. The case concerns a related party debt factoring arrangement between McKesson Canada Corporation (McKesson) and McKesson International Holdings III S.a.r.l. (factor) resident in Luxembourg.

Certain important details of the transfer pricing arrangements and the transfer pricing arguments are not apparent from the Notice of Appeal (1) and the Reply, (2) but already it appears that certain key techniques and assumptions used in this common tax planning arrangement have been called into question and in this respect McKesson will surely join GE Capital Canada, (3) GlaxoSmithKline (4) and Alberta Printed Circuits (5) as another key source of transfer pricing case law and precedent originating from Canada.

l. General features of a debt factoring arrangement

It is worth recapping first of all the standard features of an invoicing discounting arrangement. A good source is the US Internal Revenue Service “Factoring of Receivables Audit Techniques Guide” dated June 2006 (LMSB-04-0606-004). (6) This advises that

“the factor typically charges interest on the advance plus a commission. (7) The price paid for the receivables is discounted from their face amount to take into account the likelihood of uncollectability of some of the receivables…a factor may provide any of the following services: (8)

1. Investigation of the credit risk of the client
2. Assumption of the credit risk of the customers
3. Collection of the client’s accounts receivable from the customers
4. Bookkeeping and reporting services related to accounts receivable
5. Provision of expertise related to disputes, returns and adjustments
6. Advancing or financing…

the taxpayer pays the foreign factor the following fees: a discount; administration fees; commission; and interest (9) …however, the foreign [related party] factor does not perform any of the typical services of a factor, including collection of the taxpayer’s accounts receivable. Instead, the taxpayer agrees to continue doing all or most of its own collection work on its accounts receivable.”…

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Disclaimer

(1) McKesson Canada Corporation v The Queen, Notice of Appeal (Part 1 Reassessment), Court File No 2008-2949(IT)G, 18 September 2008 and Amended Notice of Appeal, 17 December 2010.
(2) McKesson Canada Corporation v The Queen, Amended Reply to Notice of Appeal, Court File No 2008-2949(IT)G, 12 January 2011 and Reply to Amended Notice of Appeal (Part XIII) dated 12 January 2011.
(3) 2010, Canadian Federal Court of Appeal.
(4) 2010, Canadian Federal Court of Appeal.
(5) 2011, Tax Court of Canada.
(6) N.B. This guide appears to be current as of 17 March 2011 – see IRS website page: www.irs.gov/businesses/article/0,,id=159770,00.html
(7) While the economics of factoring are somewhat akin to lending, so that the price of the receivable will include an interest-like component to compensate that factor for the time it is out of funds (i.e. the period between the purchase and the maturity date of the receivable), that is built into the discount applied by the factor in determining the purchase price – there is actually no loan or advance as such in a factoring arrangement, only the purchase of an asset (i.e. the receivable).
(8) “Managing Factoring in Banking Groups”, Discussion Paper 1/2006, Credifact April 2006, pp 5-6, observes that factoring involves a combination of receivables financing, insurance and services.
(9) See footnote 8; in practice all services are paid for through the discount.

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