Valuation Perspectives
on Tax Developments
Insight
July 2010
Transfer Pricing Rules in Canada: An Overview
“Subsection 247(3) imposes
a penalty in instances where
the taxpayer fails to make
‘reasonable efforts’ to
determine and use
arms-length transfer prices.”
Canada, like the United States and other countries that follow the Organization for Economic
Cooperation and Development (OECD) guidelines, bases its approach to transfer pricing, i.e. the tax
treatment of cross-border transactions between related parties, on the arms-length principle. In this
issue of the Tax Insight newsletter, we provide an overview of transfer pricing guidelines in Canada,
and explain some of the key similarities/differences to the U.S. transfer pricing rules.
The following is an overview of the major provisions of Canada’s transfer pricing policies:
• Section 247 of the Canadian Income Tax Act provides the statutory framework for its transfer
pricing law. Subsection 247(3) imposes penalties for a taxpayer’s failure to make “reasonable
efforts” to determine and use arm’s-length transfer prices.
• Subsection 247(10) authorizes the Minister of the Canadian Revenue Agency (CRA) to adjust
the terms of cross-border related party transactions where they are inconsistent with the armslength principle. This provision closely parallels IRC Section 482 in the United States.
• Subsection 247(4) mandates a “contemporaneous documentation,” which is similar to the U.S.
requirement for contemporaneous documentation under IRC Section 1.6662.
DOCUMENTATION REQUIREMENTS
Subsection 247(3) imposes a penalty in instances where the taxpayer fails to make “reasonable efforts”
to determine and use arms-length transfer prices. The penalty is calculated as 10 percent of the
taxpayer’s reduced, unfavorable transfer pricing adjustments if they exceed the lesser of $5 million
(Canadian dollars) or 10 percent of the taxpayer’s gross revenue. Conversely, in the United States the
penalty is a percentage of the actual tax paid.
Subsection 247(4) of the Income Tax Act imposes a set of documentation requirements which must
be met for the taxpayer to be deemed to have made “reasonable efforts” to determine and use arm’slength transfer prices or allocations. The taxpayer must prepare or obtain the required documentation
within six months from the end of its tax year. Upon request from the CRA, the taxpayer must
present the required documentation within three months after receipt of a written request to do so.
Failure to present the documentation on time will result in the taxpayer being deemed to have failed
to make “reasonable efforts.”
The taxpayer must also file an annual return, Form T106, Information Return of Non-Arms
Length Transactions with Non-Residents, which requires the filer to attest that contemporaneous
documentation exists by checking a box on the form. It is important to note that if the taxpayer
doesn’t have the documentation but has checked the box it could be construed as fraud. While the
U.S. has a similar form (5471), the form does not include a box to verify documentation.
continued on back…
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Valuation Perspectives
on Tax Developments
Insight
Transfer Pricing Rules in Canada: An Overview
ADVANCE PRICING AGREEMENTS
“Canada, like the U.S.,
imposes a thorough set of
documentation requirements,
and imposes penalties for
failure to comply.”
Like the U.S., the CRA has an Advance Pricing Agreement (APA) program to help taxpayers
determine appropriate transfer pricing methods. The process of obtaining an APA is laid out in
IC 94-4R. The term of an APA is usually three to five years, but may vary depending on the facts,
circumstances, and resolution of the particular case. The taxpayer must file APA reports according to
the terms of its APA. An APA report will describe the taxpayer’s actual operations for the period and
demonstrate its compliance with the terms and conditions of its APA.
RECENT DEVELOPMENTS
In a recent court case involving GlaxoSmithKline, Inc., the Tax Court of Canada considered the
question of whether or not it should analyze both the purchase price paid under the supply agreement
and the royalty paid under the licensing agreement together, or instead analyze each agreement
separately. The case centered around the proper transfer price of a key ingredient in one of its drugs.
Glaxo’s position was that the supply and licensing agreements were inseparable, and the company’s
concern was for the total “net transfer price.” The CRA argued that each element of the transaction
was distinct and warranted “distinct tax consideration.”
The Court sided with the CRA and determined that the reasonableness of each agreement must
be analyzed separately. As a result of this determination, the Court held that with respect to the
supply agreement, generic drug transactions constituted appropriate comparables. The case has been
interpreted as an indication that Canada strictly applies the hierarchy of methods provided by the
OECD guidelines, and that it strongly prefers the comparable uncontrolled price method and other
transaction methods over profit-split methods.
CONSISTENCIES WITH THE U.S.
To summarize, Canada closely follows the OECD Guidelines, and has structured its statutory law,
case law, and administrative guidance around the idea that Canada’s law is essentially an application
of the Guidelines. In addition, Canada and the U.S. are consistent on the following issues:
• Canada, like the U.S., imposes a thorough set of documentation requirements, and imposes
penalties for failure to comply.
• Canada has followed the same trend as the U.S. in developing and expanding its APA program
• Transfer pricing issues in Canada, as in the U.S., are subject to increasing emphasis and scrutiny
by tax authorities, and the field is subject to change and development.
VRC has extensive experience assisting clients with transfer pricing engagements. For more
information contact your VRC representative. VR
Editor: Theresa Liu © Valuation Research Corporation. All rights reserved.
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