CRA recently released a new Transfer Pricing Memorandum (TPM-15)
giving detailed guidance on CRA's audit approach to management
fees and other charges for intra-group services, including on
allocation keys for indirect chargebacks and markups on costs. The
document expands considerably upon brief guidance on this topic in
CRA's main Information Circular on Transfer Pricing, which
dates back to 1999. The new TPM is therefore a useful roadmap for
Canadian companies, large and small, that pay service fees to or
receive fees from related non-resident entities. It is clear that
CRA is expecting a more granular level of detail in documenting
intra-group services, even routine ones, than is commonplace in
many companies and may not be entirely practical. Taxpayers should
carefully consider the level of documentation that currently exists
in their organization and whether it needs to be upgraded.
CRA identifies two main issues in evaluating intra-group
services: (1) whether a service has been provided and (2)
determining the arm's length value of the service. CRA notes
that the same framework is to be used consistently whether the
Canadian taxpayer is the payor or the recipient of the fee,
suggesting that transfer pricing auditors will be considering the
bona fides of any fees paid by Canadian companies (not
merely leaving the issue of deductibility of such fees as a
domestic audit matter).
A services contract or intercompany invoices will only be a
starting point for an auditor's analysis under the framework.
Taxpayers' documentation should include a detailed description
of the services and rationale from both the perspective of the
provider and the recipient that establishes the benefit of the
service to the recipient.
It's important to note that CRA does not accept certain
amounts charged to Canadian subsidiaries, including activity costs
of a foreign parent company (also referred to as stewardship costs)
and charges for non-Canadian entities in the group. In a welcome
development, however, CRA does acknowledge that certain foreign
regulatory costs incurred by a foreign parent, such as those
related to Sarbanes-Oxley compliance, may benefit Canadian
subsidiaries if the requirements overlap with Canadian regulations
and in such cases, a charge could be justified, albeit on a
As to the methods of charging, the direct method, which attaches
specific charges to services, is preferred by CRA and should be
used where possible, including if similar services are provided to
arm's length parties; however, the CRA acknowledges that an
indirect method, i.e., an allocation of pooled costs will
often be necessary. In such cases, taxpayers should keep records of
the composition of the cost pools in order to justify the amounts
in each pool, to separate out any elements that are non-deductible
or restricted under Canadian tax law (including stock option
amounts, certain interest charges, meals and entertainment charges,
etc.) and to select an appropriate allocation key for the
particular pool. The new TPM makes it clear that CRA will not
accept a one-size-fits-all approach in choosing an allocation key.
The TPM instructs auditors not to accept proportion of sales
revenue as a single allocation key; rather, the allocation key must
be appropriate to the cost. For example, time spent may be
appropriate for allocating charges for legal, tax and data
processing services and use of a corporate jet; whereas, number of
employees may be a more suitable allocation key for internal HR
charges. Care should be taken to avoid duplicate costs and in this
regard taxpayers should avoid giving different charges similar
labels, which can cause confusion on the part of auditors and give
rise to requests for further detail that could have been
The TPM notes that markups should not be automatic and are not
warranted in all cases. Instead, the validity of a markup in a
particular case will depend on a functional analysis and a detailed
review of facts and circumstances. Even where a profit element is
justified, the profit element and any savings accruing to the group
as a whole must be fairly shared.
In summary, the trend in all aspects of transfer pricing
documentation is to ever greater detail, from country-by-country
reporting recommended by the OECD as part of its BEPS Action Plan
to even routine intra-group service arrangements, as elaborated
upon by CRA in new TPM-15. If you have concerns about the adequacy
of your documentation or are facing an audit, seek privileged
advice from legal counsel to mitigate exposure and enhance
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
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