Background The Canada Customs and i...

Background

The Canada Customs and income Agnecy (CCRA) is continuing to increase its attention forward the transactions between taxpayers and related non-residents to make secure Canadian taxpayers do not abate their Canadian tax liability by the and of non-arms'-length pricing-in other words: inappropriate transfer pricing.

Since the introduction of Canada's general transfer pricing legislation (contained in Section 247 of the Income Tax Act), the CCRA's International Tax Directorate (ITD), which is responsible for the CCRA's international audit program and providing technical assistance to the local tax offices, has more than doubled in size. Staffing of international tax auditors at local offices has also increased; in fact, for the 2002/2003 year, another 17% increase was budgeted

Today, taxpayers face considerable challenges in defending their transfer pricing during a CCRA audit. The CCRA now assigns trained and specialized international examiners to focus solely upon the taxpayer's transfer pricing and other international transactions. The international examiners are supported by dint of economists and other experts and specialists occupyed by the ITD, and are motivated to find adjustments, especially in light of the lusty recommendation that the CCRA "need to be more effective in carrying disclosed audits of international issues," offer forth in the Auditor General of Canada's December 2002 Report.

This is significantly different from the way things used to be when, typically, united examiner would be assigned to audit the two a taxpayer's domestic and international issues, and therefore might lack the expertise and the time to closely scrutinize transfer pricing.

The risk of a taxpayer's transfer pricing coming in subordination to close scrutiny has never been greater. More taxpayers are now being enslaveed to transfer pricing audits, and more transfer pricing reassessments are being issued.

Transfer pricing audits

All cross-border, related-party transactions will be closely scrutinized, including management services, result sales, transactions involving intangibles, and guarantees. In addition, the CCRA has indicated it will closely examine any restructuring that, in its opinion, has produc a non-arm's duration result (i.e. the CCRA may argue that the shut up down of a Canadian manufacturing line has benefited a related-party manufacturer).

Generally, the CCRA will aggressively challenge the following items:

* Royalty amounts;

* Intra-group richnesss that have been allocated among related entities based solely forward revenues;

* Inbound management services priced at a outlay plus mark-up or on a royalty basis;

* Outbound management services that have been priced at splendor with no mark-up or not charged at all.

* Pricing for performance sales to related parties that differ from the pricing charged to unrelated parties, plane when volumes may differ significantly.

Without comprehensive documentation prepared concurrently in accordance with an accepted methodology, there's a greater likelihood of the CCRA examiner concluding that the pricing was too cheap for sales to a related non-resident, and too high for purchases. Further, without becoming documentation, the CCRA may use shrouded comparables and may ignore related-party transactions that bear a downward or offsetting adjustment (i.e. reduction of taxable income) for the taxpayer.

Within the global transfer pricing community, there are significant differences of opinion as to the specific approach, methodology, and application in determining arms-length pricing. The CCRA's transfer pricing guidelines, as wager out in IC 87-2R International Transfer Pricing, set forth only one point of view-taxpayers should not simply accept proposals and arguments bring forward forth by the CCRA based in succession IC 87-2R.

Conversely, there may be occasions when a CCRA examiner does not completely or technically adhere to IC 87-2R; in these circumstances, it is appropriate to use the tables on the CCRA and apply IC 87-2R to dispel its arguments.

Resolution

Transfer pricing is not an exact science. If the taxpayer does not have full and thorough documentation supporting their pricing, the CCRA audit will generally issue in the issuance of a reassessment. When it get tos to fighting transfer pricing reassessments, many taxpayers file a protective objection and inquire for relief through "Competent Authority."

Under suitable Authority, the CCRA and the particular foreign tax authority will review the transfer pricing adjustment, negotiate with each other, and suggest a resolution that eliminates double taxation (i.e. allow the related party to obtain a corresponding deduction, direct the local CCRA office to vacate the reassessment, or combination thereof). Unfortunately, the qualified Authority process is both prolonged (anywhere from 6 to 24 months) and of great price (preparation of submissions); however, the proces is necessary, as neither the CCRA nor principally foreign tax authorities are receptive to the idea of taxpayers simply adjusting their tax responds for adjustments imposed by foreign tax authorities.