A collection of transfer pricing summaries of countries in the

North America region

Transfer Pricing | 2018

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Transfer Pricing | 2018 The AGN North America Transfer Pricing Surveys of the following countries:

Index

Canada 3

“This publication has been prepared for the purpose of quick information dissemination. Its contents should not be used as a basis for advice or formulating decisions under any circumstances.”

AGN International - North America Limited

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CANADA 2018 TRANSFER PRICING

1. TPlegislation/guidelines

Canada’s transfer pricing legislation embodies the arm’s length principleand is found in section 247 of the Income Tax Act. Subsection 247(2) isthe main provision giving CRA wide authority to adjust a taxpayer’s crossborder transfer pricing. 247(2) states that, if the terms or conditions of atransaction between persons not dealing at arm’s length differ from thosethat would have been made between persons dealing at arm’s length, anyamounts recorded in respect of the transaction shall be adjusted to theamounts that would have been determined if the transaction had beenbetween persons dealing at arm’s length.The primary source of transfer pricing guidance from Canada RevenueAgency (“CRA”) is Information Circular 87-2R “International TransferPricing”. Circular 87-2R is a comprehensive document that providesguidance from CRA on all aspects of international transfer pricing. CRAhas also issued topic specific circulars such as 94-4R “Advance PricingArrangements”, 94-4R-SR “Advance Pricing Arrangements for SmallBusinesses” and 06-1 “Income Tax Transfer Pricing and CustomsValuation.

2. TPdocumentationrequired to befiled with taxreturn

Detailed transfer pricing information must be filed with a tax return if thetotal value of transactions with non-arm’s length non-residents in theyear exceeds $1,000,000. If the $1,000,000 threshold is exceeded, FormT106 “Information Return of Non-Arm’s Length Transactions with NonResidents”must be filed. Form T106 is a two-part information return thatconsists of a T106 summary and one or more T106 slips. The T106summary reports general information such as the filer’s gross revenue forthe year, the gross value of all non-arm’s length transactions, nature ofthe taxpayer’s business activities, whether an advance pricingarrangement has been entered into, etc. A T106 slip is prepared for eachnon-arm’s length non-resident person with whom the taxpayer transactedduring the year. Transactional reporting is broken down in detail on theslips and includes inventory purchases and sales, rents, royalties,management fees, marketing, technical fees, R&D expenses,commissions, interest, dividends, lease payments, expensereimbursements, etc. Loans and advances as well as intercompanyaccounts payable and receivable balances are also reported. Thetaxpayer is required to disclose whether its transfer pricing transactionsare supported by contemporaneous documentation.

3. TP auditsdone by taxauthority

Though transfer pricing adjustments have always been part of CRA’sgeneral audit program, transfer pricing as a separate audit division staffedby trained transfer pricing auditors was introduced by CRA circa 1990.Since then, CRA auditors have aggressively pursued transfer pricing auditsand reassessments. Auditors have generally been found to be far morelenient with taxpayers who can demonstrate a meaningful attempt wasmade to establish and adhere to bona fide transfer pricing policies.

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3. TP auditsdone by taxauthority [cont.]

Taxpayers with little or no documentation to support their transfer pricingoften find themselves facing material transfer pricing reassessments.While a handful of transfer pricing disputes have found their way into thecourts over the years, most disputes are settled at the audit stage.Taxpayer are more inclined to seek a compensating adjustment to the taxreturns of the related company through the competent authority thanengage in what can become a costly and lengthy court battle. Canadiancourts are also generally more inclined to opine on matters of law ratherthan mundane aspects of alternative transfer pricing methodologies.

4. AdvancePricingArrangements

CRA’s Advance Pricing Arrangement (“APA”) program assists taxpayers indetermining acceptable transfer prices. An APA stipulates a mutuallyacceptable transfer pricing method to be used on specified internationaltransactions for a future period and generally includes renewal provisions.An APA provides protection against transfer pricing adjustments by CRA aslong as the APA remains in effect and the taxpayer complies with all termsand conditions. An APA with CRA is often considered to be of little valuebecause the APA does not prevent a foreign country from adjusting atransfer price. A bilateral APA under which a foreign country agrees to thesame transfer pricing methodology provides assurance that both countrieswill respect the APA.

5. MutualAgreementProcedures

One of the main benefits of Canada’s wide network of treaties is theelimination of double taxation that can result from a reallocation ofrevenues from international transactions. Most of Canada’s treatiescontain rules that allocate income in accordance with the arm’s lengthprinciple and are modelled on the OECD Model Tax Convention. Treatiesalso include provisions for seeking relief from double taxation.If an adjustment made or proposed to be made by a foreign tax authoritywill adversely affect a Canadian taxpayer, the Canadian taxpayer mustseek the assistance of the Canadian Competent Authority before makingcorresponding adjustments on their Canadian income tax return. Ataxpayer is not permitted to simply adjust their own Canadian tax returnas a time saving matter of convenience.Transfer pricing penalties are not a compliance issue covered by mutualagreement procedures in treaties. The Canadian Competent Authority willnot negotiate with foreign revenue authorities regarding Canada’s right toapply transfer pricing penalties; nor will the Canadian Competent Authoritychallenge the position of foreign tax authorities on the application of theirtransfer pricing penalties.

6. Basis torecoverintra-groupservice charges

A wide variety of services are often provided by one member of amultinational group to other members within the group. These intra-groupservices may be of an administrative, technical, financial, or commercialnature. Canada follows the OECD Guidelines on providing intra-groupservices, which include a framework to determine whether a charge for aparticular service is justified; and, if so, how to determine the amount ofthe charge.

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6. Basis torecoverintra-groupservice charges[cont.]

Intra-group service charges are subject to the same arm’s length standardas all other cross border charges. In applying the arm’s length principle tointra-group services, a taxpayer must first determine whether a specificactivity performed by a member of the group for another member is aservice for which a charge is justified. An arm’s length entity would pay foran activity only to the extent that the activity confers on it a benefit ofeconomic or commercial value. Where it would not have been reasonableto expect the entity to either pay an arm’s length entity for the activity orto perform it itself, it is unlikely any charge for the activity would bejustified.

7. Cross bordermanagementfee charges

Under domestic law, management fees paid to related non-residents aregenerally subject to 25% withholding tax. While the term “managementfee” is seldom, if ever, found in tax treaties, Canada and its treatypartners generally considered management fees to fall within a company’sbusiness profits. Accordingly, management fees are protected fromCanadian taxation under the business profits article of a tax treaty as longas the fees reflect an arm’s length amount and the service provider(usually the parent company) does not have a permanent establishmentin Canada.

8. Intercompanyloans

A loan by a Canadian company to its foreign subsidiary may benon-interest bearing if the funds are used by the subsidiary in anactive business carried on in the foreign country. Interest at theprescribed rate must generally be charged on all other loans tonon-residents. Depending on the facts, a loan to a related nonresidentcould become a deemed dividend subject to withholdingtax.An interest bearing loan to a Canadian company by a related nonresidentis subject to Canada’s 1:5:1 debt to equity thincapitalization rule. Interest denied under the thin capitalization ruleis deemed to be a dividend subject to withholding tax. Tax treatiesdo not override Canada’s thin capitalization rules.

9. Transferpricingpenalties

A 10% penalty applies to the net result of all transfer pricingadjustments minus the amount of adjustments for which a taxpayerhas made reasonable efforts to determine and use arm’s lengthtransfer prices. The penalty only applies if the net amountcalculated above exceeds the lesser of $5,000,000 and 10% of thetaxpayer’s gross revenue for the year. Subsection 247(4) deems ataxpayer not to have made reasonable efforts unless the taxpayerhas prepared contemporaneous documentation. There are also late filing penalties; failure to file penalties; and falsestatement or omissions penalties associated with an incorrect,incomplete or late filed form T106.

Firm: Adam & Miles LLP www.adamsmiles.com Contact: Glen MacMillan - gmacmillan@adamsmiles.com

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