Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.
Principal Issues: Transfer Pricing
Would CRA consider working with the IRS to develop a coordinated approach to transfer pricing audits that minimizes transfer pricing reassessments based on differing assumptions, especially where the taxpayer has not attempted to use transfer pricing to reduce its overall tax liabilities and has fully documented its analysis in establishing arm's length pricing with its U.S. entities?
Position: See response.
2011 TEI-CRA Liaison Meeting
December 6, 2011
Question 10 - Transfer Pricing (1)
Michael Danilack, Deputy Commissioner (International), Large Business & International, of the Internal Revenue Service made remarks during TEI's 61st Midyear Conference in Washington, D.C. (April 5, 2011) in respect of transfer pricing and competent authority negotiations that we believe are apropos to Canada. (footnote 1) Specifically, CRA auditors commonly assert transfer pricing positions that differ from those of the taxpayer because, as Mr. Danilack notes, it is easy to do so by simply "invoking a different comparable set, applying a different methodology, or pointing to extraneous factual considerations." The ability of auditors to make adjustments "because they can," however, frustrates taxpayers and is contrary to the underlying premise of a self-assessment system.
Since many Canadian transfer pricing disputes involving a U.S. counterpart will be referred to Competent Authority and if unresolved within a two-year timeframe be subject to the arbitration provisions of the Canada-U.S. Tax Treaty, it would be more efficient for the government and taxpayers to minimize transfer pricing reassessments, especially where the taxpayer has a well-documented transfer pricing analysis. Would CRA consider working with the IRS to develop a coordinated approach to transfer pricing audits that minimizes transfer pricing reassessments based on differing assumptions, especially where the taxpayer has not attempted to use transfer pricing to reduce its overall tax liabilities and has fully documented its analysis in establishing arm's length pricing with its related U.S. entities? We invite CRA's comments.
The CRA has the responsibility of protecting Canada's federal and provincial tax base by ensuring compliance with its domestic and treaty legislation. Thus compliance initiatives are an essential part of a functional self-assessment system, and the CRA intends on maintaining its compliance activities.
As a member of the OECD, Canada endorses the OECD Transfer Pricing Guidelines and the arm's length principle in the application of its transfer pricing legislation. The CRA is of the opinion that the proposed approach would be at odds with the arm's length principle and should not be considered. Further, in the context of Canada's high level of inbound transactions, such an approach would risk eroding Canada's federal and provincial tax bases.
The determination of arm's length prices and allocations is a fact-based process. The fact that a multi-national enterprise (MNE) has documented its analysis of arm's length prices and has not attempted to reduce its overall tax liability is not proper assurance that all facts and circumstances have been considered and that income has been adequately allocated between jurisdictions. Nevertheless, the fact that a reassessment is raised as a result of transfer pricing adjustments does not indicate that the CRA believes that a taxpayer has deliberately manipulated its taxes.
The CRA understands concerns where amounts subject to reassessments are not material however acceptance of materiality is understandably different from the perspective of a Canadian taxpayer compared to a much larger US company.
In order to increase efficiency of transfer pricing audits, the CRA stresses the importance of a risk-based approach to file selection, proper assessment of facts and circumstances relevant to OECD comparability factors, well supported and documented audit files, and assessments that respect the arm's length principle. Efficiency may also be gained if information required to perform a proper review of a taxpayer's facts and circumstances were available on a timely basis, thus allowing international tax auditors to make timely conclusions. Documentation exchanges through exchange of information services and simultaneous or joint audit efforts would also lead to increased efficiency.
The issues raised in this question may also be raised with the OECD Working Party No. 6 at the Annual Meeting on Transfer Pricing of the Global Forum on Treaties and Transfer Pricing or through its project on the administrative aspects of transfer pricing.
Note to reader: Because of our system requirements, the footnotes contained in the original document are shown below instead:
1 Mr. Danilack said:
I suggest that [Article 9 of the OECD Model Tax Convention can] also be read to mean that, if the taxpayer has, in good faith, completed a sound analysis to establish an arm's length result under accepted transfer pricing principles and fully documented that effort in both countries, and if it's apparent from the situation, and from all the evidence, that the taxpayer has not misused transfer pricing to reduce its overall tax burden, then the treaty should limit the ability of either contracting state to make an adjustment.
I put forward this proposition because, as we all know, it's relatively easy to challenge any transfer price or expense allocation simply by invoking a different comparable set, applying a different methodology, or pointing to extraneous factual considerations. If reallocation were permissible in any case in which two enterprises are related or controlled, then virtually every cross-border reporting position would be subject to proposed reallocation and presentation to [competent authority] for resolution. In other words, just because a decent examiner or economist can dive into a case and come up with a different set of numbers in a country's favor shouldn't mean that the adjustment is permitted under the treaty and should be presented to the other country for correlative adjustment. To prevent this from happening, I think it's important for the adjusting country to show that, in fact, there are conditions made or imposed between the enterprises differing from those which would be made between independent enterprises and that those conditions involved mispricing to gain a tax advantage.
Further, I'll point out that, in the competent authority process, the adjusting country has the burden of proof in this regard. First, paragraph 2 of Article 9 makes clear that the specific conditions supporting the reallocation must distinguish the case from a situation in which those conditions don't exist. In addition, the OECD commentary on paragraph 2 of Article 9 makes clear that the country from which relief is requested is required to provide correlative relief only if it determines the adjustment is justified, both in terms of principle and in terms of the amount . . . .
If the taxpayer has conducted a strong analysis to establish arm's length results under accepted principles and fully documented that effort in both countries, and if it's apparent from the situation that the taxpayer hasn't misused transfer pricing to reduce its overall tax burden, then the treaty should operate to limit the ability of either contracting state to make an adjustment. Personally, I believe this concept is critical to ensuring that both taxpayers and competent authorities are not overwhelmed with proposed adjustments triggered by nothing more than common ownership and some of the subtleties that can lead to pointy-headed debates when applying the arm's length standard.
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