Canada: Primer On Transfer Pricing Audits

Last Updated: March 15 2012
Article by Salvatore Mirandola, Patrick Lindsay and Stephanie Wong

Most Read Contributor in Canada, September 2016

Transfer pricing attracts a lot of attention from tax authorities, generally because large amounts are often involved and most countries are concerned with protecting their own tax base. Transfer pricing refers to the manner in which prices for goods and services are determined among entities within the same corporate group and in different countries. In general, where a corporate group has one entity in a country acquiring goods and services (e.g., raw materials, inventory, royalties for the use of IP, or finance-related services) from another entity in a different country, the price they agree to pay for those goods and services (the "transfer price") affects how much income is realized (and how much tax is paid) in each country. Because different countries have different tax rates, there is an incentive to have an entity in the higher-tax country incur more expenses (i.e., pay higher transfer prices for goods and services received) and minimize income (i.e., charge less for services rendered or goods sold) on transactions with a group member in a lower-tax country. To control transfer pricing, the tax systems of advanced countries generally have rules which effectively adjust the price to an "arm's-length" price where an entity in that country has paid too much or charged too little for goods and services in a transaction with a non-arm's-length entity in another country.

Canada's tax authorities are aggressive in challenging taxpayers on transfer pricing. Transfer pricing audits can take a lot of time and resources, even if the taxpayer is ultimately successful. One of the biggest dangers for taxpayers is that the tax authorities of the two countries involved (for example, Canada and the U.S.) may not agree on what the "correct" arm's-length price is for a transaction between affiliates in each country, and in those circumstances double tax results. For example, Canada may allow the Canadian entity only a deduction for $50M even though it has paid $75 million to a related U.S. entity, while the U.S. treats the U.S. entity as having received $75M of income. In the case of Canada-U.S. transfer pricing disputes, that problem may potentially be alleviated under new mandatory arbitration rules which were added by the most recent protocol to the Canada-U.S. Income Tax Convention (the "Treaty").

On February 28, 2012, the Toronto Centre Canada Revenue Agency (CRA) and Professionals Consultation Group, co-chaired by Steve Suarez of BLG, hosted a breakfast seminar at which a panel of speakers from the CRA and private practice discussed what to expect from a transfer pricing audit and how best to manage the process and achieve a favourable outcome. The panel also discussed the new mandatory arbitration rules in the Treaty. The following discussion summarizes and highlights key points of the two panel discussions.


The local CRA tax services office serving the taxpayer will conduct the transfer pricing audit. Generally, the audit process consists of three stages: research, analysis and resolution.


At the research stage, the CRA auditor's goal is to understand the taxpayer's business and how it functions within its corporate group, to determine where business value is added and by which entities in the group, and to identify suitable comparables within the taxpayer's industry. Generally, the auditor will assemble the audit team and have an initial meeting with the taxpayer to present the audit plan and to formally request the taxpayer's contemporaneous transfer pricing documentation pursuant to the transfer pricing rules in section 247 of the Income Tax Act (Canada) (the "ITA"). Once the CRA has made the request, the taxpayer has three months to provide its contemporaneous documentation.1 Taxpayers need to keep in mind that this is a hard deadline and the CRA will not extend it. Penalties may apply if a taxpayer does not maintain sufficient contemporaneous documentation as required.

The CRA audit team will request, gather and review tax, financial and other information related to the taxpayer as well as to other members of its corporate group (whether Canadian or foreign). Typically the CRA's information requests are very detailed and wide-ranging, with the CRA requesting (in addition to corporate books and records), organizational and staff charts, documentation from foreign tax authorities (and other foreign-based information) and business plans. The CRA may also ask the taxpayer to generate information that it does not normally keep. It is important to note that the authority granted to the CRA under the ITA to obtain information from taxpayers is broad, but there are limits. For example, the CRA cannot legally compel the taxpayer to provide information that is protected by solicitor-client privilege.

The CRA will also conduct interviews and site visits with key officers and employees. The costs relating to site visits are often a contentious issue: generally, site visit costs for visits outside of Canada are borne by the taxpayer. Taxpayers should be aware that the auditor will also look at the taxpayer's marketing and other business or promotional materials (including the information provided on its website) to see whether the description of the services provided by the taxpayer is consistent with its transfer pricing, tax and financial documentation. Often, the CRA will look closely at such assets as R&D and intangibles within the group.

During the panel discussion, the CRA panelists emphasized that it is generally in the taxpayer's interest to provide the CRA with sufficient information to allow the CRA to perform a principled and efficient transfer pricing audit.


At the analysis stage, the CRA will review the taxpayer's transfer pricing analysis and all available supporting documentation and conduct its own transfer pricing analysis, which will include evaluating comparable taxpayers and/or transactions, if any. In reviewing the taxpayer's transfer pricing analysis, the CRA will take a detailed look at the entire value chain within the corporate group, including margins at each level, as well as consistency (or variance) in cost methods and comparables used in relation to functions, assets, risks and other business factors. In evaluating comparables, the CRA can draw on multiple sources, including its extensive database and library of information on Canadian taxpayers as well as industry knowledge.

If the CRA identifies deficiencies in the taxpayer's transfer pricing analysis, then those should normally be addressed in the CRA's own transfer pricing analysis of the taxpayer's business. During the analysis, the audit team may assign an economist to the audit file if required; it may also obtain the assistance of other specialists within the CRA and, in certain circumstances, seek advice from external industry specialists. Generally, if the economist's analysis supports the auditor's position, the CRA will not deviate from that position.


At the resolution stage, the CRA will issue a 30-day proposal letter informing the taxpayer how it intends to reassess for the year(s) at issue. If the transfer pricing assessment exceeds a specific minimum threshold, the auditor will automatically include in the proposal letter a transfer pricing penalty determined pursuant to subsection 247(3) of the ITA. As the penalty does not apply if the taxpayer has made reasonable efforts to determine an arm's length transfer price, the taxpayer will generally want to ensure that the CRA has sufficient facts at this stage to support the conclusion that the taxpayer has made such reasonable efforts.

This stage also provides the CRA and the taxpayer with the opportunity to discuss any unresolved issues, to make further submissions and to provide/receive clarification on any outstanding questions. If the taxpayer experiences a problem with the auditor that cannot be resolved, the taxpayer should work up the management chain at the local TSO to resolve it, as CRA Headquarters does not normally deal with audits.

Taxpayers should note that the CRA generally does not negotiate transfer pricing cases at the audit stage. Negotiations usually will not begin until the case proceeds to the appeals level at the CRA or to the mutual agreement procedure ("MAP") stage under a relevant tax treaty.

Overall, the CRA's audit process and resolution will be driven by any applicable statute of limitations for reassessments under a relevant tax treaty with Canada. For example, under the Treaty, if Canada issues a transfer pricing reassessment to a Canadian taxpayer, it generally must notify the U.S. tax authorities of the reassessment within six years after the end of the affected taxation year of the taxpayer.


Canada's first mandatory arbitration provision, contained in the Treaty, took effect on December 15, 2008; prior to that date, arbitration was only available if the two countries' tax authorities voluntarily agreed to it. Typically, the tax authorities of Canada and the U.S. meet to negotiate double tax cases under the Treaty's MAP four times per year, and usually take about three negotiation sessions to resolve a case (if it is resolved).

Under the Treaty's new mandatory arbitration provision, certain tax disputes that cannot be resolved within two years are subject to mandatory arbitration if the taxpayer requests it. The tax authorities can also mutually agree to accelerate a taxpayer's right to arbitration where resolution of a dispute is unlikely, or to delay the arbitration if on-going MAP negotiations remain productive.

Mandatory arbitration is generally available for disputes relating to the existence of (and attribution of profits to) a permanent establishment (PE), royalties, and residency for treaty purposes, as well as to unresolved Canada-U.S. advance pricing agreement (APA) cases. However, Canadian and U.S. tax authorities have some discretion to include or exclude cases from arbitration. Interest on unpaid tax and penalties are outside the scope of the arbitration.

The CRA and the Internal Revenue Service have agreed to arbitration procedures which are set out in a Memorandum of Understanding (effective November 12, 2010).2 As shown in Figure 1 (presented at the seminar), specific time limits apply to each stage in the arbitration process, subject to limited exceptions. For example, if required information is missing, the tax authorities can delay the commencement of arbitration.

Mandatory arbitration under the Treaty is conducted "baseball style", i.e., for each separate issue under dispute the arbitration panel must select one of the two countries' positions (rather than creating a compromise solution). Since the panel does not provide any rationale or analysis for its decision, the decision has no precedential value, i.e., it applies only to the specific tax issue and taxation year(s). The three-person arbitration panel is assembled by having each country appoint one person, with those two appointees then selecting (by consensus) the third person who acts as the Chair of the panel. The panel's determination (by majority vote) generally must be made within six months after the Chair has been appointed and is binding on both countries. The concerned taxpayer must accept the determination within 30 calendar days of receiving it, or the taxpayer is considered to have rejected it and the tax authorities can proceed with their reassessments. The arbitration may be terminated prior to the panel's decision if the concerned taxpayer so requests it, or if the countries' tax authorities agree on a settlement.

It is important to note that special rules, procedures and timelines may apply in arbitrations involving APAs, PE issues, or accelerated requests or where multiple tax issues are under dispute.

For taxpayers, the chief advantages of pursuing the MAP and mandatory arbitration procedure under the Treaty over the CRA's domestic appeals process is obtaining tax certainty for transfer pricing issues in both treaty countries simultaneously, reducing or eliminating double taxation, and potentially incurring lower costs as compared to litigation. On the downside, the taxpayer is not involved in the MAP negotiations (while it would participate in the CRA appeals process), and generally the taxpayer's only option is to accept or reject a MAP settlement or mandatory arbitration decision. However, there is flexibility in the process since taxpayers can still pursue the CRA's appeals process if they decide to reject the MAP settlement or mandatory arbitration decision under the Treaty.

Overall, the mandatory arbitration provision in the Treaty may help Canadian taxpayers involved in double tax disputes with the U.S. by reducing the time it takes for resolving those disputes, as well as by motivating Canadian and U.S. tax authorities to reach a compromise before arbitration becomes necessary. It may also encourage them to more carefully evaluate the strength of their positions and the reasonableness of their proposed reassessments (since they risk being overturned by a mandatory arbitration panel).


1 See CRA Transfer Pricing Memorandum TP-05, Contemporaneous Documentation, available at

2 See the CRA's website at

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