Canada US Transfer Pricing - what are the issues?

CANADA US TRANSFER PRICING AGREEMENTS
Updated: March 23, 2009

For more information contact Jonathan Levy at jlevy@uhyvictor.com. Jonathan is the Chairperson of the UHY Canada US Tax Team. UHY Victor (Montréal) prepares transfer pricing reports.

Click here to obtain the most recent copy of our UHY Global Transfer Pricing Guide.


CANADA US TRANSFER PRICING – A DEFINITION
Transfer prices are prices that companies charge for goods, services, tangible and intangible assets they trade with subsidiaries and other controlled entities. Given that these transfer prices are set internally by management, they are frequently subject to scrutiny by both the IRS and the CRA.

Tax authorities concur that the proper transfer price is one which two parties dealing at arm's length would agree to. Consequently, the objective of transfer pricing experts is to determine what is the "arm's length price" or “market price” is for any particular situation.

In recent years both the CRA and the IRS have increased their emphasis on transfer pricing audits. Both these tax authorities require companies to have documentary evidence supporting their transfer prices.

The Pacific Association of Tax Administrators (PATA), which include Australia, Canada, Japan and the United States, have created a “Transfer Pricing Documentation Package” so that one set of transfer pricing documentation can meet the respective transfer pricing documentation requirements in multiple jurisdictions, and these are integrated into the following text.

A proper analysis of many factors is required to determine a transfer price, including:

  • Nature of the company's activities
  • Risks
  • Tangible and intangible assets employed
  • Characterization of the entities and comparability of arm's length with non-arm's length transactions.


CANADA US TRANSFER PRICING AGREEMENTS - REGULATIONS IN CANADA
In the absence of proper transfer pricing documentation, the tax auditor is required to assess a penalty of 10% of the net adjustment of the transfer price.

In addition, companies are required to have transfer pricing documentation that is current ,and it must be provided to the CRA within three months of a written request to do so.


CANADA US TRANSFER PRICING AGREEMENTS – AN OVERVIEW
Companies start their transfer pricing analysis by identifying the transactions between related parties, which generally fall into the following areas:

1. Transfer of tangible products such as inventory.

2. Transfer of services such as management and administration services.

3. Transfer of intangible assets such as the use of a patent or copyright.

4. Transfer of tangible capital assets such as machinery and equipment.

5. Intra-group loans.


CANADA US TRANSFER PRICING AGREEMENTS – INDUSTRY & MARKET ANALYSIS
The industry and market analysis provides a description of the general business environment, and includes:

Industry profile.

Market size and level of concentration.

General profiles of competitors, their size, strategies and market shares.

Current trends in the industry.

Critical success factors.


CANADA US TRANSFER PRICING AGREEMENTS – FUNCTIONAL ANALYSIS
Functional analysis is at the core of the transfer pricing study and includes analysis of:

1. Functions – which entity carries out the following which activities:
Design
Manufacturing
Financing
Inbound logistics
R & D
Inventory management
Outbound logistics
Marketing
Sales activities
After-sale services
Supporting activities

2. Risks – which entity bears the risks associated with the transaction, and include:
Financial risk
Credit and collection risk
Operational risk
Market risk
Product risk

3. Intangible assets - which entity:
Developed the intangibles
Has the legal ownership of the intangibles
Receives the benefit of the intangibles.


CANADA US TRANSFER PRICING AGREEMENTS – SELECTION OF A TRANSFER PRICING METHOD
The CRA provides the following hierarchy of the following five methods:

1. Comparable Uncontrolled Price (CUP) method
2. Resale Price (R-) method
3. Cost Plus (C+) method.
4. Profit Split (PS) method
5. Transactional Net Margin method (TNMM).

The CRA requires that the CUP method be used if possible. In cases where the CUP method is not feasible, one of the remaining four methods are to be used. In the rare case that it is not possible to use any of the above methods, other unspecified methods may be used. However, in general, it is not advisable to use unspecified methods.

The selection of a method will depend on the functional analysis and availability of comparable transactions. If it is possible to use the internal CUP method, then the selection of a method can be relatively straight-forward.


CANADA US TRANSFER PRICING AGREEMENTS – ECONOMIC ANALYSIS
The economic analysis provides the following:

selection of comparable transactions or companies

consideration of the quality of data

assumptions and comparability factors

selection of appropriate economic and statistical methods

profit level indicators

quantification of appropriate adjustments


CANADA US TRANSFER PRICING AGREEMENTS – RECOMMENDATION
The recommendation is a clear statement of the recommended transfer pricing policy.


CANADA US TRANSFER PRICING AGREEMENTS – IMPLEMENTATION & MONITORING
This section details the most efficient method of implementing the selected transfer pricing policy.

A transfer pricing study should be updated each year to reflect any material changes in the transactions under consideration. Provided that no material changes have occurred, an update is generally simple and straightforward.

Since every study must be prepared by the filing due date (generally 6 months after the corporate year end), it is advisable to monitor and document all the changes as they occur during the year. If circumstances change such that some or all transactions did not represent an arm's length price, it is possible to record a compensating year-end adjustment. This adjustment should be fully documented.

CANADA US TRANSFER PRICING AGREEMENTS – DOCUMENTATION (APPENDICES)
The appendices should include documentation that supports conclusions reached regarding the transfer price.

CANADA – US TRANSFER PRICING AGREEMENTS - RESOURCES

CRA
Income Tax Act Section 247
IC 87-2R International Transfer Pricing
IC 94-4R International Transfer Pricing: Advance Pricing Arrangements (APAs)
IC 71-17R4 Requests for Competent Authority Considerations

CRA Forms:
T106 - Information Return of Non-Arm's Length Transactions with Non-Residents
T1134A - Information Return Relating to Foreign Affiliates That Are Not Controlled Affiliates
T1134B - Information Return Relating to Controlled Foreign Affiliates
T1141 - Information Return in Respect of Transfers or Loans to a Non-Resident Trust
T1142 - Information Return in Respect of Distributions from and Indebtedness to a Non-Resident Trust

Canadian Treaties - Ministry of Finance
Canada - US Tax Convention

IRS

Internal Revenue Code - section 482

OECD
Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations

Other
PATA Transfer Pricing Documentation Package

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DISCLAIMER:
While every effort has been made to ensure that this site contains accurate information, it is possible that errors do exist in the materials presented. All of the information provided here is provided “as is”, with no guarantees of completeness, accuracy or timelines, and without warranties of any kind, express or implied. The information presented on this site should not be considered to be, or construed as legal, economic, tax, or accounting advice.

UHY Victor - For Montréal Transfer Pricing

759 Square Victoria, Suite 400

Montréal, Québec, H2Y 2J7


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