9.2.1 [a] Related and Non-Arm’s Length Persons
Canadian tax law as it relates to transfer pricing transactions is premised on the fundamental principle that, unless expressly permitted by the Act, tax consequences of all transactions, including dispositions of property, should be determined in accordance with the arm’s length principle.
The Act contemplates the following circumstances when persons, including non-residents, are not considered to deal with each other at arm’s length:
- Related persons are deemed not to deal with each other at arm’s length, regardless of their actual conduct or dealings;
- A person and a personal trust are deemed not to deal with each other at arm’s length if the person (or any person not dealing at arm’s length with the particular person) is beneficially interested in the trust; and
- Where particular persons are not related, it is a question of fact whether such persons are dealing with each other in arm’s length.
The Act also contemplates that in certain circumstances unrelated persons may not deal at arm’s length with each other and provides to that effect that it is a question of fact whether otherwise unrelated persons are dealing at arm’s length. The following criteria may generally be used to determine whether unrelated persons have dealt, in respect of a particular transaction, at arm’s length:
- Whether there was a common mind that directs the bargaining for both parties to the transaction;
- Whether the parties to the transaction were acting in concert without separate interests; and
- Whether there was “de facto” control of one party by another party.
9.2.1 [b] Transfer Pricing
In an international tax context, where a particular transaction between a taxpayer and a non-resident not dealing with the taxpayer at arm’s length is found not to respect the arm’s length principle, Canadian tax authorities may have recourse to a broad range of measures available under the Act, including transfer pricing adjustments and transfer pricing penalties stipulated in section 247 of the Act.
Subsection 247(2)
Subsection 247(2) is the main transfer pricing provision in the Act that in essence allows Canadian tax authorities to determine Canadian tax consequences of a cross-border transaction between non-arm’s length persons as if they have dealt with each other at arm’s length.
Subsection 247(2) applies where a taxpayer and a non-resident person with whom the taxpayer does not deal at arm’s length are participants in a transaction (or series of transactions) and one of the following conditions is present:
- The terms or conditions of the transaction differ from those that would have been made between persons dealing at arm’s length; or
- The transaction would not have been entered into between persons dealing at arm’s length and can reasonably be considered not to have been entered into primarily for bona fide purposes other than to obtain a tax benefit.
Where subsection 247(2) applies, the CRA may make a transfer pricing adjustment with the goal that the relevant amounts for the purposes of the Act reflect the quantum or nature of the amounts that would have been determined in the participants had dealt with each other at arm’s length. Further, the CRA may impose on the taxpayer withholding tax and a broad range of interest charges and penalties, including transfer pricing penalty set out in subsection 247(3).
Where the application of subsection 247(2) results in a transfer pricing adjustment, a taxpayer may be subject to a transfer pricing penalty set out in subsection 247(3).
The transfer pricing penalty under subsection 247(3) does not apply if a taxpayer’s transfer pricing adjustment has not exceeded the certain de minimis quantitative threshold or a taxpayer is eligible to claim the due diligence defense in respect of its transfer pricing determinations:
- De Minimis Test. The transfer pricing penalty in subsection 247(3) applies only where, in a particular taxation year, the net amount of transfer pricing adjustments has exceeded the lesser of (i) $5,000,000; or (ii) 10 percent of a taxpayer’s gross revenue for the particular taxation year.
- Due Diligence Defense. The transfer pricing penalty in subsection 247(3) may not apply where a taxpayer made reasonable efforts (i) to determine arm’s length transfer prices or arm’s length allocations in respect of the transaction; and (ii) to use those prices or allocations for the purposes of the Act.
Foreign Affiliate Exception
The Act exempts certain loans made by Canadian corporation to its controlled foreign affiliate from the application of the transfer pricing rules in subsection 247(2), where such loans are used by the foreign affiliate to earn income from an active business or certain income deemed by subsection 95(2) to be income from an active business.
Where a taxpayer is subject to a transfer pricing adjustment under subsection 247(2), in certain circumstances the taxpayer may also be liable for additional withholding tax under Part XIII of the Act computed with reference to the amount of the transfer pricing adjustment.
Where the taxpayer is found by the CRA to be subject to a secondary adjustment, the CRA may grant relief for Part CIII withholding tax in the following circumstances:
- The Canadian taxpayer agrees in writing to the proposed transfer pricing adjustments;
- The adjustments did not arise from a transaction that may be considered abusive; and
- The non-resident person repatriates the funds equivalent to the gross amount arising from the transfer pricing adjustment immediately or agrees in writing to repatriate such amount within a reasonable time.
9.2.1 [d] Other Provisions
In addition to transfer pricing provisions in section 247 of the Act, the CRA may seek to apply other provision of the Act that may affect the tax consequences of transactions between non-arm’s length parties both in domestic and cross-border context.
References:
Advisor’s Guide to Canada – U.S. Tax Treaty
By: Vitaly Timokhov, Raymond Montero, David Kerzner
Published by: Thomson Carswell