Transfer Pricing Issues
As is the case with most major counties, Canada has rules in its tax laws aimed at preventing income from being shifted to other jurisdictions by unreasonable transfer pricing [1].
To date, most of the activity of the CRA and reported tax cases has focused more on inbound transfer pricing issues involving charges by multi-national corporations to Canadian subsidiaries. However, the rules can certainly be applied in connection with outbound tax planning of the type being outlined in this series [2].
If the CRA successfully applies these rules, they could lead to a reassessment of Canco’s income on the basis that Forco did not pay a high enough price for goods or services provided by Canco, or that Canco paid Forco too high a price for goods or services supplied by Forco.
Furthermore, the CRA has an extended period during which it can reassess Canco in connection with adjustments resulting from a transfer-pricing audit-they are allowed an additional three years [3].
Accordingly, careful attention should be paid to the nature of any transactions that will occur between Canco and Forco to determine whether or not a reasonable fee or price is or will be charged.
Furthermore, in the event of a CRA audit, Canco should be able to provide the CRA with “contemporaneous documentation” that was prepared at the time the pricing was set to show that it was reasonable [4].
Form T106, which must be submitted to the CRA by Canco in any year where the transactions between it and Forco total more than $1,000,000, is used by the CRA, in part, to help it police such transactions.
In considering the reasonableness of transfer pricing, the representative of Canco should go beyond the obvious and ask such questions as “Are there any services that Canco provides to Forco for which it is not being charged at all?” “Is there any IP of Canco that Forco uses where no royalty or licensing fee is charged?” Or, even more significantly, “is it possible that Canco could be viewed as having disposed of all or part of its business to Canco, thereby resulting in deemed proceeds and gains for ‘goodwill’ and IP?”
At all times, it is important to look at the operations of Forco and think about what exactly Forco is doing to earn its income, and the extent to which any inputs from Canada contribute to that process.
In the next article in this series, I will discuss some basic issues in relation to offshore tax planning and the use of Forco to hold IP that has or will be developed by Canco.
Endnotes
[1] Section 247
[2] Probably the most famous reported case involving an outbound transfer pricing issue is The Queen vs. Irving Oil Limited, 91 DTC 5106 (FCA), which involved a Canadian company that purchased oil from an offshore affiliate. The CRA challenged the mark-up that was used, but lost.
[3] Subparagraph 152(4)(b)(iii)
[4] Subsection 247(4)
[5] Subparagraph 95(2)(a)(i)
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