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Canada: Year-end preparation, checklist for transfer pricing

Canada: Year-end preparation, transfer pricing

The year-end is an opportune time for taxpayers to consider reviewing their transfer pricing and customs priorities.

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Taxpayers may need to evaluate whether to adjust related-party payments or transactions, amend existing transfer pricing policy or agreements, or establish transfer pricing policies for new transactions or lines of business.

It is important to take a holistic approach when reviewing related-party payments and transactions or transfer pricing policies, and examine them from both an income tax and a customs perspective. When considering customs, remember that the Canada Revenue Agency (CRA) and the Canada Border Services Agency (CBSA) administer their own distinct set of rules for income taxes and custom duties. Unfortunately, as a result, some approaches may be beneficial from an income tax perspective while having a detrimental effect from a customs duties perspective (or vice versa).

In light of this, consider the following set of transfer pricing items when completing year-end tasks and wrapping up projects.

Transfer pricing considerations

Consider early on whether it is necessary to make a transfer pricing adjustment to transactions in the year, since such adjustments may also affect customs duties and goods and services tax (GST) / harmonized sales tax (HST).


Identify all relevant transactions

  • Have all transactions with related parties been identified?
  • Were there any new related-party transactions during the year?
  • Are related parties sharing, using or licensing intellectual property?


Confirm financial results are consistent with transfer pricing policies

  • Confirm whether profits realized by each entity in the group are aligned with the entity or group's transfer pricing policy
  • Consider whether each entity's accounting records clearly demonstrate the correct application of the transfer pricing policy
  • Check for unexpected losses or unusual gains after applying the transfer pricing policy
  • Ask whether profitable companies are being remunerated commensurately with the value they generate

It is also important to determine whether the relevant documentation (e.g., benchmarking analyses, external comparables, etc.) supports the arm's length price used. In addition, it may be prudent to revisit a transfer pricing policy and related supporting documentation to support arm's length pricing if the following have changed:

  • Functions performed
  • Assets employed
  • Market conditions
  • Risk profiles


Exceptional and/or new costs

Review any exceptional/new costs in the financial statements to:

  • Assess their impact
  • Ascertain whether to recharge these costs to another entity in the group and identify the appropriate recipient
  • Assess whether to apply a mark-up to the exceptional/new costs and at which rate
  • Consider how the mark-up rate should be supported, if one is being added to exceptional/new costs


Intellectual property

  • Determine whether royalties related to intellectual property are properly accounted for in the transfer price
  • Investigate whether inbound or outbound royalties have been creating unusual volatility (i.e., unusual losses or gains)


Intercompany financing

  • Consider whether it may be appropriate to repay intercompany financing in light of the current interest rate environment (if repayment options are available for intercompany debt)
  • Assess whether debt covenants on intercompany loans have been monitored
  • Determine whether the tax team has reviewed thin capitalization calculations and other tax rules related to intercompany financing


Payment of intercompany amounts

  • Some jurisdictions require certain intercompany charges to be paid before the payer can be entitled to a tax deduction.


Attribution of profits to a permanent establishment

  • In instances when a non-resident entity has a Canadian branch—or a Canadian entity has a foreign branch—verify the attribution of profits to the permanent establishment(s) is determined using the principles of the relevant, applicable bilateral treaty, if any.


Legal documentation

  • Determine that legal documentation is in place to substantiate any related-party transactions
  • Determine whether these legal agreements have been properly executed and reflect the current state of transactions and interactions between the parties involved


Prior year exposures

  • Identify any tax exposures that may have arisen in past tax years that may need to be addressed—for example, issues in prior-year Form T106, Information Return of Non-arm's Length Transactions with Non-residents, prior-year true-ups, etc.


Final considerations

  • After finishing a review, it may be worthwhile to step back and assess the big picture of the financial results. It is not unusual for CRA auditors to ask taxpayers why they did not think of the above noted issues at the time of their transactions. It can be helpful to be proactive. If not satisfied with the numbers being reported in the accounts after this review, it may be appropriate to revisit the transactions and amend the underlying transfer pricing policies used, to be consistent with the review's conclusions.

Customs considerations resulting from transfer pricing adjustments

Companies that transfer physical goods between Canada and the United States (or other countries) must deal with two revenue collection authorities (CRA and CBSA) and satisfy each authority's distinct transfer pricing rules.

The CBSA is generally concerned with unduly low prices for imported goods (which could reduce customs duties). It often examines the relevant agreements for other payments made between the related parties to determine whether those payments need to be included in the price of the goods for customs valuation purposes. When the CBSA reviews an incomplete or limited agreement, it commonly determines that management fees, royalties, or other amounts to be paid to related parties must be added to the value for customs purposes.

Conversely, the CRA is concerned with unjustifiably high prices for imported goods (which result in larger deductions that can reduce income tax).

When establishing an intercompany agreement with transfer pricing implications, some issues to consider for customs purposes include:

  • Management services and fees — Will management services be part of the agreement? Could any management fees payable be allocated to physical goods crossing the border?
  • Original selling price — How will the original selling price of imported goods be determined?
  • Royalties — Will a royalty be payable to a related party? If so, what are the conditions of the royalty?
  • Research and development costs — Do costs for research and development form part of the intercompany agreement?
  • Mould and design charges — Are moulds or designs supplied to related manufacturers free of charge or are they included in the price of the goods?
  • Agent commissions — Are related parties providing services that could be considered buying or selling agent commissions and, if so, are any of these commissions subject to customs duties?
  • Price adjustments — If a good's transfer price must be adjusted after the good is imported, how will this adjustment affect the value of imported good for customs purposes?


Year-end adjustments

Taxpayers may need to make year-end adjustments to related-party transactions to bring their transfer price within an arm's length range, usually in accordance with their transfer pricing policy. These adjustments are made for income tax purposes and may take the form of a lump-sum adjustment to sales or the cost of goods sold, depending on the inbound or outbound nature of the transaction. From a customs' perspective, such an adjustment may be considered part of the customs value of the previously imported goods. Remember that year-end adjustments require further analysis in order to determine whether additional duties are payable.

GST/HST implications

Taxpayers also need to consider GST/HST implications when revising related-party payments, intercompany transactions or transfer pricing policies. Adjustments that increase prices or costs may mean that additional GST/HST must be collected, while decreases may necessitate a refund of previously charged GST/HST, depending on the circumstances.


Read a December 2019 report prepared by the KPMG member firm in Canada

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