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Documentation and reporting
Rules and procedures
What rules and procedures govern the preparation and filing of transfer pricing documentation (including submission deadlines or timeframes)?
Other than Form T106 (discussed below), Canada does not require taxpayers to prepare, maintain or file transfer pricing documentation. However, in order to avoid the 10% transfer pricing penalty (discussed below) which can apply where taxpayers have not made reasonable efforts to determine the arm’s-length price that should be used to transact, taxpayers must contemporaneously prepare and maintain documentation in support of their transfer prices. Under Sub-section 247(4) of the Income Tax Act, taxpayers will be deemed not to have made reasonable efforts for the purposes of the 10% transfer pricing penalty where the documentation is not:
- complete and accurate in all material respects;
- prepared contemporaneously; or
- provided within three months of being requested.
For the year in which a transaction is entered into, a taxpayer must make or obtain records or documents that provide a complete and accurate description of the transaction within six months from the end of the taxation year. Further, the taxpayer must provide the Canada Revenue Agency (CRA) with such documentation within three months of a written request.
In addition, a taxpayer that is resident in Canada or not resident in Canada but carries out business in Canada must file a T106 Form where the aggregate amount of reportable transactions with non-resident persons exceeds C$1 million. There are three specific penalties that may apply where a taxpayer fails to comply with the T106 reporting and filing requirements which can range from C$2,500 per failure to comply with requirements to C$24,000 for filing incorrect or incomplete forms (Section 233.1 of the Income Tax Act).
The Income Tax Act contains other foreign reporting obligations relating to the holding of foreign properties and certain transactions with foreign trusts and non-resident corporations. Significant penalties may apply for non-compliance with these rules (Sections 233.2 to 233.4 and Section 233.6 of the act).
What content requirements apply to transfer pricing documentation? Are master-file/local-file and country-by-country reporting required?
For transfer pricing purposes, taxpayers must draft or obtain documents or records that provide complete and accurate descriptions of:
- the property or services to which the transaction relates;
- the terms and conditions of the transaction and their relationship, if any, to the terms and conditions of other transactions entered into between the participants;
- the identity of the participants in the transaction and their relationship to each other at the time that the transaction was entered into;
- the functions performed, the property used or contributed to and the risks assumed (this is also known as the ‘functional analysis’) in respect of the transaction by the participants in the transaction;
- the data and methods considered and the analysis performed to determine the transfer prices or the allocation of profits or losses or contributions to costs, as the case may be, in respect of the transaction; and
- the assumptions, strategies and policies, if any, that influenced the determination of the transfer prices or the allocation of profits or losses or contributions to costs, as the case may be, in respect of the transaction (Sub-section 247(4) of the act).
If the transaction continues into subsequent taxation years or fiscal periods, the taxpayer must describe only the material changes in a complete and accurate manner. If there are no material changes in a year, no new documentation is required. Nonetheless, taxpayers will generally prepare reports annually in order to minimise or reduce the risk of a penalty and a transfer audit.
Canada has enacted legislation to implement the country-by-country reporting obligations set out in Action 13 of the Organisation for Economic Cooperation and Development (OECD) Base Erosion and Profit Shifting (BEPS) final report (Section 233.8 of the Income Tax Act).
The rules apply to fiscal years of certain multinational enterprises (MNEs) that begin on or after January 1 2016. In general, Canadian-resident parents of MNEs and Canadian-resident subsidiaries of MNEs (where certain secondary reporting requirements are met) must comply with annual country-by-country reporting requirements by filing a Form RC4649.
In accordance with the OECD BEPS final report, country-by-country reporting is required only for MNEs with an aggregate annual consolidated group revenue of €750 million or more.
What are the penalties for non-compliance with documentation and reporting requirements?
In addition to any interest and penalties resulting from the transfer pricing adjustment itself, taxpayers may be subject to an additional 10% penalty for failure to have made “reasonable efforts” to determine arm’s-length transfer prices (Sub-section 247(3) of the Income Tax Act). Such penalty can be avoided or reduced where the taxpayer “made reasonable efforts to determine arm's length prices” and used such prices (Sub-section 247(4) of the act). As noted above, a taxpayer will be deemed not to have made reasonable efforts where it does not meet the contemporaneous documentation criteria set out in Sub-section 247(4) of the act.
This 10% penalty is imposed on a taxpayer where its transfer pricing capital and income adjustments exceed a de minimis amount, which is the lessor of the ‘threshold’ (ie, 10% of the taxpayer’s gross revenue for the year before the application of the transfer pricing rules or C$5 million). The penalty may apply in situations where there are no increases in taxes payable pursuant to the transfer pricing adjustment, as the penalty is based on the quantum of the transfer pricing adjustment and not the increase in tax payable.
An anti-avoidance provision prevents taxpayers from avoiding the penalty by increasing gross revenues to meet the threshold.
In addition, as noted above, resident taxpayers and non-resident taxpayers carrying on business in Canada may be subject to a separate penalty for failure to file a Form T106.
What best practices should be considered when compiling and maintaining transfer pricing documentation (eg, in terms of risk assessment and audits)?
The main goals of preparing transfer pricing documentation are to:
- mitigate the risk of penalties arising from a failure to make “reasonable efforts” to determine the arm’s length transfer price; and
- reduce transfer pricing audit risk.
Taxpayers should follow the following best practices in managing their transfer pricing compliance and audit risks:
- Profits attributable to the less complex party to the transaction should not be below industry norms, unless this can be underpinned by specific facts and circumstances.
- Transactions with related entities located offshore or in low-tax jurisdictions should be thoroughly documented, as they are subject to additional scrutiny by the Canadian tax authorities.
- Royalty payments should not be used to strip profits from related parties (aggressive royalty payments are a common transfer pricing audit trigger).
- The determination of the arm’s-length value of management fees should be properly documented and the economic reality underpinning the price of such services should be analysed extensively.
- Intangible asset transfers should not be used as a way to reduce the global taxes paid by a multinational enterprise (ie, by transferring such assets to entities subject to tax in low-tax jurisdiction).
- Taxpayers should determine the correct transfer pricing method on a case-by-case basis and adapt such methods to the specific facts and circumstances of each relevant transaction.
- Taxpayers should document their dealings with related non-residents and prices should always be determined pursuant to a transfer pricing method recognised by the CRA (such prices should also be used consistently by all taxpayer members of the same multinational enterprise).
- Any restructuring transaction (defined by the OECD as the cross-border redeployment by a multinational enterprise of functions, assets and risks) should be subject to a substantive transfer pricing analysis and documentation, as the CRA focuses on such transactions for transfer pricing audit purposes.
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