Tax Articles
Doing business across the border? Get your documents in order!
Henrik Swaneveld
BDO Dunwoody LLP
September / October 2005, Enterprise
If your company conducts business across the border with non-arm’s length parties, you now need specified transfer pricing documents.
The Canada Revenue Agency (CRA) is striving to protect its revenue base in light of surging international trade—and suspected profit manipulation. The government believes that capital is moving out of this country and into low-tax jurisdictions or tax havens and is determined to put a stop to this.
This is one of the reasons why the CRA, the tax authority responsible for administering legislation governing international trade, transformed itself in 1999 from Revenue Canada into the Canada Customs and Revenue Agency and finally, into the Canada Revenue Agency. This transformation produced a more aggressive and efficient body to deal with the surge of cross-border business transactions involving goods, services, and intangibles. Until now, however, the renamed Canada Revenue Agency has focused on large transactions—generally those above $1 million.
Under a new directive issued to field audit staff at the end of 2004, transactions of virtually any size will now be scrutinized if they are material in nature. “Transactions” refers to the purchase and/or the sale of goods or services, intangibles and other significant cross-border transactions. Virtually all Canadian companies that conduct cross-border business with related (non-arm’s length) parties in other countries will be impacted.
The Income Tax Act defines “related” as a corporation, and, either:
- a person who controls the corporation,
- a person who is a member of a related group that is in control of the corporation, or anyone who may be related to an individual fitting the former two provisions.
The definition also applies where one person or group controls any two corporations, or separate but related groups or individuals control them. Clearly, any circumstance in which a corporation deals with a subsidiary, parent or sister company is considered not to be operating at arm’s length.
The new directive now makes it mandatory that CRA auditors request transfer pricing documents at the beginning of any audit of a business involved in such transactions. Previously, auditors could exercise their own discretion before requesting this documentation—and generally did not request it for small transactions.
As well, the CRA will ask for these documents when the audit begins and you must comply within three months. Previously, auditors could extend this timeline, again at their discretion.
The term “transfer pricing” refers to international pricing arrangements within an organization or among organizations that belong to the same corporate group.
Canadian tax regulations require that taxpayers prepare appropriate transfer pricing documentation to confirm that the amounts charged in related party transactions are consistent with the amounts that would be charged to arm’s-length entities.
Where you do not have the appropriate documentation to substantiate your cross-border transactions, for example, the CRA can apply penalties of 10% on the total adjustment it makes to a transaction, plus interest—of which are tax deductible.
Companies are required to provide a detailed description of these transactions. This description is outlined in the Canadian Income Tax Act and is referred to as “contemporaneous documentation.” The Act requires taxpayers to maintain current, comprehensive information regarding transactions with related parties. This documentation is intended to explain the business context in which the transactions take place and to provide an opportunity to support the basis of the transfer prices used. This documentation includes the following six categories of information.
- A detailed description of the product or service supplied to the non-resident-related party;
- The terms and conditions of the transactions;
- The identities and relationships of all participants involved in the transactions;
- An activity and risk analysis (an assessment of the facts and circumstances of the transaction), including the functions performed, risks assumed and assets utilized by the parties involved;
- The data and methods used to calculate the transfer price;
- All assumptions, strategies, and policies that affected the transfer price.
Along with preventing a reassessment by the CRA, there is another important advantage to having the right transfer pricing documents: lower taxes. If a company’s transfer price is too high, as often happens, your business could be paying substantially more taxes than necessary.
To ensure that you have the right transfer prices and documents, you would be wise to consult with a transfer-pricing specialist. This professional can conduct an activity and risk analysis; select the appropriate transfer pricing methodology; conduct an evaluation with arm’slength comparable companies; and prepare the appropriate documentation to meet the CRA’s requirements.
Increasingly, international tax auditors are auditing transfer prices for transactions of all sizes, both to evaluate accuracy and to eliminate opportunities for profit manipulation. Don’t wait for the CRA to audit your company before preparing the necessary documentation or you could find yourself unable to meet the three-month deadline. Some due diligence now just might save you from a costly reassessment later.
Hendrik Swaneveld, CA is the partner-in-charge of the BDO Dunwoody (www.bdo.ca) transfer pricing and competent authority services team. BDO is one of Canada’s leading accounting and advisory firms, which helps entrepreneurs and family businesses succeed. If you have questions about this article or you would like to receive BDO’s “Tax Factor” newsletter, contact Hendrik in the Markham office at (905) 946-2526 or by e-mail at hswaneveld@bdo.ca.
