This is article is part of a series dealing with draft legislation released for comment by the Department of Finance on July 29th. Read the complete series:
- The evolving taxation of derivatives
- Sales of linked notes
- Taxation of switch fund shares
- Alternative arguments in support of tax assessments
- Proposed replacement of eligible capital property rules by new depreciable property class
Businesses with international operations need to be aware of changes to the required transfer pricing documentation that will apply in the near future. In Canada, for instance, the government has already taken steps to introduce legislation in respect of transfer pricing documentation which will be effective for fiscal years that begin after 2015.
These changes arise out of the final report released on Oct. 5, 2015 by the Organization for Economic Cooperation and Development ("OECD") with its 15-point Action Plan on Base Erosion and Profit Shifting ("BEPS"). The Canadian government, in Budget 2016, announced its support of certain recommendations made in the BEPS final reports, including those recommendations pertaining to Action 13 on Transfer Pricing Documentation and Country-by-Country Reporting ("CbC reporting"). On July 29, 2016, the Department of Finance released draft legislation dealing with CbC reporting.
This article will provide a brief overview of the recommendations, current framework for legislative transfer pricing documentation requirements in Canada, and the recent proposed legislative changes.
BEPS Action 13 — Final Recommendations
The OECD's final report on BEPS Action 13 recommends that countries adopt a standardised approach to transfer pricing documentation. The objective is to provide tax administrations with better information for conducting risk assessments of transfer pricing situations. These final recommendations are consistent with the global trend towards greater tax transparency by multi-national enterprises ("MNEs"). The final report recommended a three-tiered structure consisting of:
- A master file containing standardised information relevant for all MNE group members.
- A local file referring specifically to material transactions of the local taxpayer.
- A CbC report containing certain information relating to the global allocation of the MNE's income and taxes paid together with certain indicators of the location of economic activity within the MNE group.
The following is a brief summary of the information required in each of the three categories of documents described above.
The master file is intended to provide an overview of the MNE group and should provide/include:
- The MNE group's legal and geographical organisational structure.
- An overview of the MNE group's business, including the nature of its global business operations and important profit drivers.
- Lists of important agreements, intangibles and transactions.
- The MNE's intercompany financial activities.
- The MNE's financial and tax positions.
The information required in the local file supplements the master file and helps to meet the objective of assuring that the MNE has complied with the arm's length principle in its material transfer pricing positions in a specific jurisdiction. The local file focuses on information relevant to the transfer pricing analysis related to transactions taking place between a local country affiliate and associated enterprises in other countries which are material in the context of the local country's tax system. Such information would include:
- Relevant financial information regarding those specific transactions.
- A comparability analysis.
- The selection and application of the most appropriate transfer pricing method.
The CbC report requires aggregate tax jurisdiction-wide information relating to the global allocation of the income, taxes paid, and certain indicators of the location of economic activity among tax jurisdictions in which the MNE group operates. The report also requires a listing of all the constituent entities for which financial information is reported, including the tax jurisdiction of incorporation, where different from the tax jurisdiction of residence, as well as the nature of the main business activities carried out by that constituent entity.
In accordance with the OECD's recommendations, CbC reporting would apply to large MNEs with total annual consolidated group revenue of €750 million or more. Such MNEs would be required to file a CbC report with the MNE's parent entity's tax administration. A CbC reporting template has been designed by the OECD and will include the global allocation, by country, of key details of the MNE, including: revenue, profit, tax paid, stated capital, accumulated earnings, number of employees and tangible assets, as well as the main activities of each subsidiary.
The parent entity of a qualifying MNE will be required to file a CbC report with its local tax administration within one year of the end of the relevant fiscal year. CbC reporting will be required for taxation years that begin after 2015.
Jurisdictions which receive a CbC report from an MNE will automatically exchange the report with all other jurisdictions in which the MNE operates, provided that the other jurisdictions have implemented CbC reporting, have a legal framework in place for automatic exchange of information, and have entered into a competent authority agreement relating to CbC reporting.
Current Legislative Framework in Canada for Transfer Pricing Documentation
The current legislative regime in Canada for transfer pricing documentation ("contemporaneous documentation") can be found in subsection 247(4) of the ITA. These contemporaneous documentation rules are clarified and expanded upon in various Canada Revenue Agency ("CRA") publications. In brief, contemporaneous documentation serves as a blueprint for explaining the rationale for the price of goods, services or intangibles established by the related parties on intercompany transactions. Contemporaneous documentation requirements in Canada typically include a transfer pricing study, which includes as a minimum the following:
- Overview of the businesses involved and the corporate structure.
- Description of the industry and competitors.
- Identifying the related party transactions.
- Functional analysis – assessing functions, assets, risks.
- Choice of transfer pricing methodology, reasons for excluding others.
- Economic analysis including selection of comparables and applying the OECD factors of comparability.
If the contemporaneous documentation is not provided to the CRA within 90 days of a request, significant transfer pricing penalties may be applicable if there is a material adjustment to the company's transfer prices and reasonable efforts were not made to determine arm's length transfer prices.
The current Canadian transfer pricing documentation legislative regime does not have any prescribed forms and templates, and simply provides a generic description of the information that a taxpayer would be expected to provide CRA to support that it has made reasonable efforts to determine an arm's length transfer price. This information would be akin to the information the OECD would like to see in the "Local File" described above.
Proposed Legislative Changes on CbC Reporting
The 2016 Legislative Proposals propose the introduction of new section 233.8, Country-by-Country Reporting, to the ITA. The requirements of proposed section 233.8 are consistent with the final BEPS Action 13 recommendations made by the OECD with respect to CbC reporting. For example, if enacted, subsection 233.8(3) would require a Canadian resident ultimate parent company, or in certain circumstances, a Canadian resident subsidiary company, to file a CbC report in prescribed form for fiscal years of the MNE that begin after 2015. MNE groups impacted by these proposed rules are defined in the proposed legislation to exclude an MNE group if, with respect to a particular fiscal year of the MNE group, it has a total consolidated group revenue of less than €750 million during the preceding fiscal year.
The prescribed form has not yet been developed, but it is expected to largely follow the CbC reporting template released by the OECD and include the CbC report information briefly described above. The prescribed form must be filed before the later of 12 months after the ultimate parent's fiscal year end or within 30 days of a notification by the Minister to an MNE entity of a "systemic failure". A "systemic failure" is a defined term in section 233.8 which deals with scenarios where there is a breakdown in the effectiveness of an existing exchange of information mechanism between Canada and another jurisdiction.
The proposed filing obligations extend to a Canadian resident subsidiary of the MNE group in those rare situations, for example, where the ultimate parent is not obligated to file a CbC report in its home jurisdiction or there is no effective mechanism for the CRA to receive the CbC report from the ultimate parent entity via exchange of information with the home jurisdiction government.
Subsection 162(10) of the ITA, the provision dealing with penalties for failure to file an information return as and when required, will be amended to include new section 233.8.
The draft legislation dealing with CbC reporting was highly anticipated and confirms the new compliance obligations for CbC reporting in Canada. Since the parent companies of many MNEs are not resident in Canada, most Canadian companies will not have to file a CbC report in accordance with proposed section 233.8. However, the Canadian subsidiaries of qualifying MNE groups will be, or already are in many cases, being called upon by the parent company to provide the necessary local information to allow the parent company to comply with its obligations under the parent's local CbC reporting regime. Even though the first CbC reports will not be due to be filed until 2017, many MNE groups are already gathering the required CbC information in order to test, and improve where necessary, their internal information gathering systems.
The interesting part of the draft legislation is that it only deals with CbC reporting and the obligations of the ultimate parent entity or designated constituent. For example, the proposed legislation does not amend subsection 247(4) to require a Canadian subsidiary to maintain the necessary local information that it will be required to provide its parent company to allow it to comply with its CbC requirements. The proposed legislation is also silent on the other components of the OECD's Action 13 recommendations pertaining to the master file and local file. For example, even though subsection 247(4) of the Act would require a Canadian resident parent company to maintain, for the most part, the information described in the OECD's recommendations regarding the local file, there would appear to be some significant gaps between the current text of subsection 247(4) and the OECD final recommendations on what should be maintained in a master file. As the OECD recommended in its final report on Action 13 "that the master file and local file elements of the transfer pricing documentation standard be implemented through local county legislation or administrative procedures", one can likely assume that the legislative omissions were intentional and CRA will eventually be called upon to update its published policies on transfer pricing documentation to better align with the OECD's final recommendations.
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.