In the transportation and logistics industry, as with other industries, it is common for corporations in the same multinational group to provide goods and services to one another. If the parties to such a transaction include a Canadian taxpayer (for Canadian income tax purposes) and a non-resident person (such as a corporation), and the parties do not deal with each other at arm’s length, the Canadian transfer pricing rules must be considered. Many jurisdictions, including Canada, have adopted robust transfer pricing rules in an effort to ensure that the appropriate amount of profits are reported in the applicable jurisdictions. If there is non-compliance with the Canadian transfer pricing rules, there can be significant penalties.
Some examples of intercompany services in this industry include a foreign entity providing the following types of services to a Canadian subsidiary or affiliate, or vice-versa: “back-office” or administrative services, such as bookkeeping, payroll services, or IT services; dispatching services; invoicing and collection services; driver vetting, hiring, monitoring and/or training; or acting as a subcontractor, among other services.
What are the transfer pricing rules?
Very generally, the transfer pricing rules are designed to ensure that cross-border transactions between non-arm’s length parties occur under arm’s length terms and conditions. The Canadian rules are contained in section 247 of the Income Tax Act (Canada) (the “ITA”). In addition, the Canada Revenue Agency (the “CRA”) publishes guidance and transfer pricing policies in a series of “Transfer Pricing Memoranda” or “TPMs.” While the CRA’s guidance and policies are helpful, they do not supersede the law.
When do the transfer pricing rules apply?
The Canadian transfer pricing rules apply when, among other things, there is a transaction between cross-border non-arm’s length parties, such as between a foreign parent corporation and a wholly owned Canadian subsidiary, or between two wholly-owned subsidiaries of the same parent corporation, one of which is Canadian. The ITA contains several rules that deem two parties to not act at arm’s length. Very generally, these deeming rules look at factors such as ownership and control. However, parties can also be acting not at arm’s length in fact. This can make determining whether two parties are dealing with each other at arm’s length a complicated and fact-specific process. The Canadian transfer pricing rules do not apply with respect to transactions involving arm’s length parties.
If the transfer pricing rules apply and the terms and conditions of the transaction do not reflect arm’s length terms and conditions, the CRA may adjust the prices or cost allocations so that they do reflect arm’s length terms and conditions. Significant penalties may also apply in certain circumstances.
Avoid penalties by taking “reasonable efforts” and by making or obtaining contemporaneous documentation
If the CRA makes adjustments in excess of a certain threshold, the CRA may assess penalties where it determines the Canadian taxpayer did not make “reasonable efforts” to determine and use arm’s length terms or conditions. Very generally, under subsection 247(4) of the ITA, a taxpayer is deemed not to have made “reasonable efforts” unless they made or obtained records or documents that provide a complete and accurate description of the transaction at issue, including the methods considered and analysis performed to determine the transfer prices.
These records or documents must be “contemporaneous,” meaning that they must be made or obtained on or before the taxpayer’s “documentation-due date.” For a corporation, the “documentation-due date” is the income tax filing-due date for the year (i.e., six months after the end of the corporation’s tax year).
If the CRA determines that the taxpayer did not make “reasonable efforts” to determine and use arm’s length terms and conditions, the CRA may assess a penalty equal to 10% of the net adjustments made by the CRA.
As a result, it is very important to ensure that there is an agreement between the entities outlining the services performed or goods purchased, the applicable fees or prices to be charged, and price adjustment language to deal with situations where the CRA or a foreign tax authority makes a transfer-pricing adjustment. Additionally, documentation demonstrating how the arm’s length fees and pricing were determined should be maintained.
The Canadian transfer pricing rules are very complex and this article only briefly touches on a few key elements. If you have concerns about whether the transfer pricing rules apply to your business, or whether your business is compliant with these rules, it is important to seek specialized advice. The members of Miller Thomson’s Transportation & Logistics Team or Corporate Tax Team would be happy to help you navigate these very complex rules.
