Canada Revenue Agency’s Responses from Tax Executive Institute Questions

The Tax Executive Institute (“TEI”) recently published written responses from their annual liaison (held on December 4-5, 2012) with the Canada Revenue Agency (“CRA”). Click here 

Of note are the questions related to transfer pricing:

Question 10 pertained to the CRA’s position on bilateral safe harbours. Safe harbours generally relate to establishing transfer pricing methods or prices/rates that would be acceptable for routine or low-risk transactions to: 1) ease audit and controversy resources of the CRA, 2) increase taxpayer certainty, and 3) reduce compliance costs. The response from the CRA does not communicate an optimistic likelihood of establishing such safe harbours until more discussion and debate has occurred at the OECD. The response by the CRA, although recognizing the potential benefits, also listed potential problems including potential compliance cost increases, more conflict with other tax jurisdictions, and potential abuse of safe harbours when taxpayers are engaged in tax planning activities.

Question 11 pertained to the CRA’s trend and the appropriateness of reassessing taxpayers using paragraph 18 (1)(a) of the Canada Income Tax Act (“ITA”) instead of section 247. Paragraph 18(1)(a) allows for a deduction in computing income from a business or property to the extent the payment is made or incurred for the purpose of earning income, whereas section 247 is the transfer pricing section of the ITA and addresses the arm’s length nature of payments made to/by related non-resident parties. If a reassessment is based on paragraph 18(1)(a), then the taxpayer may not be eligible to enter competent authority to resolve double taxation. However, if section 247 is used as the basis, then the taxpayer will have competent authority privileges. The CRA response stated there is no policy encouraging the use of paragraph 18(1)(a), and if that section was used as opposed to section 247, then there was likely no doubt to the arm’s length quantum of the transaction, but other provisions of the Act were applied. The CRA also responded that if paragraph 18(1)(a) was used, and it is clear that the issue is that of allocation of profit between jurisdictions, then the adjustment could qualify for negotiation. However, it has been the other contracting state, not Canada, which has not recognized these adjustments as a transfer pricing matter. As a result, if there is a proposed reassessment under paragraph 18(1)(a) and it is clearly an allocation of profit with a related non-resident party, consider discussing the appropriateness of section 247 versus paragraph 18(1)(a) when negotiating with the CRA so that competent authority remains a viable option.

Question 12 pertained to an update on the CRA’s risk-based approach to large business compliance. Essentially, the CRA responded that it is still early in the process to say whether any definitive trends or conclusions can be drawn. However, the CRA did state that international transactions remain a risk factor that is considered when assigning their risk-ranking to a particular taxpayer.

Global Challenge to the Ethics of Transfer Pricing

The 2013 calendar year started with negative perceptions towards transfer pricing and international tax planning matters. The UK’s Parliament Public Accounts Committee hearings has generated significant negative press, globally, in respect of low taxes paid by British operations of U.S.-owned companies. The Economist magazine published a Special Report in its February 16, 2013 issue with the following headline: “The Missing $20 Trillion: How to Stop Companies and People Dodging Taxes”. This bad press, arguably, is a key contributor to Starbuck’s public announcement of their intent to pay £20 million in the next two years over and above their UK tax liabilities.

The message from the UK Parliament is similar to the message from ActionAid, an international development charity, that released a report late in 2010 challenging the ethics – and not the legality – of the transfer pricing practices of SABMiller. With governments controlling budget deficits and the rising public scrutiny of widespread abuse of tax planning, future tax policy and revenue authority priorities will keep transfer pricing practices on the spotlight for some time to come.

In addition, the OECD released their Base Erosion and Profit Shifting (“BEPS”) report on February 12, 2013. The report was requested by the G-20 to review international tax rules, including transfer pricing rules, with the goal of helping governments better respond to multinational taxpayers who use aggressive tax planning to shift their profits to low tax jurisdictions.