Canada: World Transfer Pricing 2014: The Comprehensive Guide To The World’s Leading Transfer Pricing Firms

Originally published by International Tax Review, World Transfer Pricing 2014 -

Over the last several years, the Canadian federal tax authority, the Canada Revenue Agency (CRA), has become increasingly aggressive in auditing the affairs of multinational enterprises. In the face of growing fiscal deficits and increased demands for government spending, the CRA has devoted greater resources to reviewing international transactions that may be aimed at reducing Canadian taxes payable.

Recent Canadian legislative proposals have also imposed more extensive reporting obligations on Canadian taxpayers that enter into transactions with non-residents, and have extended the period in which such taxpayers may be reassessed if they fail to comply with such reporting requirements.

As a result of the increased scrutiny of international transactions by the Canadian government, it is critical that tax directors and their advisers properly manage Canadian transfer pricing audits.

Identification of audit targets

Any Canadian taxpayer that enters into a transaction involving a party with which it does not deal at arm's length may be at risk of being subject to a transfer pricing audit. While there is an element of chance inherent in whether a particular taxpayer will be selected for a Canadian transfer pricing audit, certain circumstances can increase the likelihood of a taxpayer being audited. Such circumstances include:

  • The persistent reporting of losses over an extended period of time;
  • The payment or receipt of material intra-group charges in respect of intangibles, services or guarantees;
  • The receipt or provision of bundled supplies;
  • Contract manufacturing arrangements;
  • Business reorganisations and/or intellectual property migrations;
  • Transactions involving parties resident in low tax jurisdictions;
  • Reporting deficiencies/anomalies on CRA Form T106, Information Return Of Non- Arm's Length Transactions With Non- Residents (including indications that the taxpayer has not prepared contemporaneous documentation in respect of a cross-border transaction); and
  • Changes to historically applied transfer pricing methodologies.

Contemporaneous documentation

The Income Tax Act (Canada) (the Tax Act) permits the CRA, in certain circumstances, to assess a special transfer pricing penalty, generally equal to 10% of the amount of any unfavourable annual net transfer pricing adjustment, if the unfavourable net adjustment exceeds a statutory safe harbour equal to the lesser of (i) C$5 million ($4.8 million), and (ii) 10% of the taxpayer's gross revenue. However, a transfer pricing penalty may not be applicable to the extent the taxpayer has "made reasonable efforts to determine arm's length transfer prices" in respect of the subject transactions. At a minimum, this requires the taxpayer to prepare contemporaneous documentation that contains a complete and accurate description of:

  • The property or service to which the transactions at issue relate;
  • The key terms and conditions of the relevant transactions and the relationship between the contracting parties;
  • The functions performed, the property used, and the risks assumed by each party to the transactions at issue;
  • The data and methods considered, and the analysis performed, to determine acceptable arm's length transfer prices; and
  • The assumptions, strategies and policies that influenced the determination of the appropriate transfer prices.

For an indication of the types of contemp - oraneous documentation that the CRA frequently seeks to review, see the "Pacific Association of Tax Administrators (PATA) Transfer Pricing Documentation Package" available at

Initiation of a transfer pricing audit

The CRA generally has broad authority under the Tax Act to inspect or examine the books, records and property of a taxpayer for any purpose related to the administration or enforcement of the Tax Act.

An audit is generally initiated by a written request by the CRA for documentation, including contemporaneous documentation as described above, in the form of a letter or audit query sheet. A copy of a typical initial CRA transfer pricing audit letter can be accessed at

Upon receiving notice from the CRA that it is initiating a transfer pricing audit, a taxpayer should promptly compile all relevant documentation in its possession. In this regard, systems should be put in place to ensure that privileged documentation is not inadvertently disclosed to the CRA.

It is critically important that a taxpayer provide requested contemporaneous documentation to the CRA within three months after being served with a written request for such documentation. A taxpayer that fails to provide contemporaneous documentation to the CRA within three months after properly being served with a request for such documentation will be deemed not to have made reasonable efforts to determine arm's length transfer prices and may be subject to transfer pricing penalties.

The CRA may obtain information regarding a taxpayer's financial and transfer pricing practices from a variety of public sources, including public company filings and the taxpayer's website. In certain cases, the CRA may also use its audit powers to request information from third parties.

The audit

Taxpayers are generally free to carry on their business during a transfer pricing audit. However, some disruption to the activities of a taxpayer is inevitable where the auditor is reviewing documentation at the taxpayer's premises.

Generally, a single representative of the taxpayer should be designated as the individual to interact with the auditor and respond to any requests for additional documentation. It may also be advantageous to have a professional adviser present during an audit to respond to queries regarding the taxpayer's rights and obligations.

The length of time needed to complete an audit will depend on the particular facts and circumstances of the taxpayer. Generally, an auditor will commence an audit by reviewing certain base documentation and thereafter may attend at the premises of the taxpayer to review additional materials and/or seek to interview certain key personnel.

Subsequent to completing his/her initial factual review, an auditor will normally issue (i) a letter indicating that no adjustments are required, or (ii) a proposal letter setting out the auditor's initial views on proposed adjustments. Taxpayers are typically provided an opportunity to respond to a CRA proposal letter with a formal submission and/or additional information.

The exchange of proposal letters and responses can extend over a lengthy period of time and it is not uncommon for an audit to last for many months. The CRA will ultimately issue a final letter setting out its proposed transfer pricing adjustments, if any, which is thereafter followed by the issuance of formal federal (and provincial) Notices of Reassessment.

The CRA has an administrative policy requiring auditors to refer matters to the CRA's Transfer Pricing Review Committee (the TPRC) before seeking to levy transfer pricing penalties or issuing an assessment to recharacterise a transaction pursuant to paragraphs 247(2)(b) and (d) of the Tax Act. Taxpayers are generally entitled to make written submissions that will be reviewed by the TPRC in such circumstances. Under CRA policy, a taxpayer is also entitled to respond to an auditor's draft statement of facts before a referral report recommending a recharacterisation assessment is delivered to the TRPC.


Advance preparation for a Canadian transfer pricing audit is the key to potentially securing a successful outcome.

There are certain common errors that many taxpayers make when managing their transfer pricing affairs, including the following:

  • Maintenance of insufficient/incomplete contemporaneous documentation;
  • Inappropriate use of transfer pricing comparables/ methodologies;
  • Failure to update contemporaneous documentation;
  • Failure to provide contemporaneous documentation within three months of a written request;
  • Failure to appreciate jurisdictional differences;
  • Failure to maintain agreements in writing;
  • No inter-affiliate coordination/consistency;
  • Compromise of legal privilege; and
  • T106 reporting errors.

Audit risk and penalty exposure can be minimised with diligent record keeping and the maintenance of detailed contemporaneous documentation. Up-to-date and organised records enable a taxpayer to advance their strongest arguments at the outset of an audit, rather than having to disabuse an auditor of an opinion that has already been formed without the benefit of certain relevant documentation.

At the outset of an audit, the taxpayer should engage the CRA auditor in a discussion of the scope of the audit review, required information, and timelines. Open and candid communication with the CRA at the beginning of an audit minimises the risk of misunderstandings or adverse inferences being drawn and generally increases the efficiency of the audit review process.

In managing a transfer pricing audit, the taxpayer must also remain mindful of limitations to seeking relief under the Competent Authority provisions of an applicable treaty and must ensure that timely notifications are made, as required.

Ultimately, diligence in establishing comprehensive transfer pricing policies and practices will help to minimise Canadian transfer pricing audit risk.

Originally published by

The foregoing provides only an overview. Readers are cautioned against making any decisions based on this material alone. Rather, a qualified lawyer should be consulted.

© Copyright 2013 McMillan LLP

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Todd A. Miller
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