Many Canadian companies who engage in cross-border transactions with related entities operating in foreign tax jurisdictions generally mitigate their transfer pricing risks by preparing transfer pricing documentation. It is preferable that the documentation is prepared on an annual basis to support the conclusion that their transfer prices are arm's length. But while appropriate documentation has often provided comfort for Canadian taxpayers when selected for an audit by the Canada Revenue Agency ("CRA”), there are those whose transfer prices may be challenged on audit. The CRA may determine that the operating margin of a Canadian taxpayer is too low and increase its taxable income.
When faced with a reassessment arising from a transfer pricing audit, the Canadian taxpayer has a number of options available and each entails its own risks and benefits.
The taxpayer may accept the reassessment and settle the additional tax liability with the CRA. This avoids the additional time and cost required to mount an appeal and allows the taxpayer to learn from the experience and devote its time to correcting its transfer prices to align with the CRA's position. This is a plausible option when the reassessment is a relatively insignificant amount compared to spending management's time and resources necessary to wage an appeal or file an objection against the reassessment.
Under Option A, the corporate group will be left with double taxation, in that the same amount of income has been taxed in two countries.
Should the taxpayer decide to challenge the CRA's reassessment, it can do so within 90 days from the date of issuance of the Notice of Reassessment (NORA) by filing Form T400A, commonly referred to as a Notice of Objection (NOO). This one-page form must be filed with the CRA's Chief of Appeals, with documents attached providing a detailed representation of the facts and the taxpayer's reasons for objection. Filing a NOO has certain advantages. For large corporations, filing the NOO requires the payment of 50% of the tax owing, keeping the CRA from collecting the entire tax owed while awaiting action on the NOO. For all taxpayers, the NOO will keep the appeals process open while initiating action to obtain relief from double taxation under one of Canada's Tax Treaties with the other country.
It should also be noted that for transfer pricing-related reassessments where the upward adjustment to income is greater than the lesser of 10% of the taxpayer's declared annual revenue in the year of the reassessment or $5 million, a transfer pricing penalty equal to 10% of the adjustment could be levied by the CRA. Once the penalty threshold is met, a reassessment is automatically referred to the CRA's Transfer Pricing Review Committee (TPRC) for review to determine whether a penalty is warranted. Typically, the TPRC examines whether the documentation met the reasonable efforts standard in deciding whether to impose the transfer pricing penalty. Transfer pricing penalties are immediately payable when imposed by the TPRC, are not tax deductible, and are not subject to relief in the Competent Authority process. Thus, the NOO would also request the removal of the transfer pricing penalty.
If the taxpayer disagrees with the CRA reassessment, it would be prudent to object and file a NOO within 90 days from the date of the NORA. Simultaneously, it should then seek Competent Authority assistance and make clear its position in the hopes that it will be adopted by the other tax authority and increase the chance of a favorable outcome for the taxpayer.
An interesting aspect of the Competent Authority process is that the taxpayer is not necessarily required to indicate that it agrees with the CRA's reassessment position in its Competent Authority submission. The taxpayer may propose a position opposite to that of the CRA and direct its foreign entity to adopt the same position in its submission to the foreign tax authority. In such a case, the taxpayer effectively invites the other tax authority to adopt its position in the hopes of a favorable outcome.
By filing the NOO, the taxpayer preserves its right to object and appeal for a favorable outcome if the CRA's position is sustained in the Competent Authority process. In this case, the NOO becomes a protective filing to keep the domestic appeals option open pending the outcome from Competent Authority.
Other considerations
Be alert for potential reassessments of foreign Entities
The Competent Authority process is time consuming. It could take two years or more before any outcome is determined and can vary depending on the tax authority the CRA will be dealing with. The Competent Authority process is not a uniform process as the procedure that directs the process varies by Tax Treaty. Thus, it is advisable that taxpayers are aware of a foreign entity undergoing a transfer pricing audit and research any nuances or additional requirements with respect to the Competent Authority procedure or tax rules followed by the foreign tax authority. For instance, some countries require that the CRA deal with state or local tax offices that oversee the foreign entity. In other instances, the reassessment period could be shorter for other tax jurisdictions and is not aligned with Canada's seven-year reassessment period, shortening the time for the taxpayer to file for Competent Authority assistance. If a taxation year is about to be statute-barred in Canada, the taxpayer should consider filing a waiver with the CRA to keep that year open to specifically deal with any transfer pricing adjustment proposed by the foreign tax authority.
Prepare contemporaneous documentation
The starting point to mitigate the risk of a transfer adjustment, the transfer pricing penalty, and the protracted process to obtain double tax relief is to ensure compliant transfer pricing documentation is in place to cover off the taxpayer's intercompany transactions with foreign entities. Subsection 247(4) broadly lists the requirements of what constitutes contemporaneous documentation. While assembling the required documentation is never a guarantee against any reassessment by the CRA, it does strongly mitigate against the application of the transfer pricing penalty should the CRA's adjustment cross the penalty threshold. The documentation is also a key element in any NOO or Competent Authority filing.
Next steps
In summary, while there are procedures available for a taxpayer in disputing a CRA reassessment and relieving its double tax impact, these demand management time, consume resources, and involve a long process. Thus, proactive planning of how the taxpayer and its foreign entities will conduct their transactions, and assembling compliant documentation to prove the transactions were conducted at arm's length help the taxpayer mitigate the risk of reassessment and the need to avail itself of double tax relief.
The transfer pricing team at BDO can help you prepare appropriate transfer pricing documentation that complies with Canadian Transfer Pricing Legislation to mitigate potential adjustments that could arise in case of a transfer pricing audit. In the event that the CRA proceeds with an adjustment, BDO can assist your company in pursuing an appropriate remedy.
Contact your local BDO office for more information
The information in this publication is current as of January 23, 2018.
This publication has been carefully prepared, but it has been written in general terms and should be seen as broad guidance only. The publication cannot be relied upon to cover specific situations and you should not act, or refrain from acting, upon the information contained therein without obtaining specific professional advice. Please contact BDO Canada LLP to discuss these matters in the context of your particular circumstances. BDO Canada LLP, its partners, employees and agents do not accept or assume any liability or duty of care for any loss arising from any action taken or not taken by anyone in reliance on the information in this publication or for any decision based on it.