Canada Revenue Agency issues new guidance on Transfer Pricing

Canada Revenue Agency (“CRA”) recently issued two new Transfer Pricing Memorandums providing new guidance on intra-group services and the role of multiple year data.

In light of this new guidance, taxpayers should review their existing transfer pricing practices and discuss it with their transfer pricing advisor.

Intra-Group Services
TPM-15, Intra-group services and section 247 of the Income Tax Act, expands the current guidance on intra-group services and clarifies CRA’s policy on audit and tax issues commonly encountered during audits.

In the memorandum, the CRA emphasized that the direct charge method is preferred over the indirect charge method when determining the prices for services provided to a group of related entities. The preferred direct charge method involves attaching a specific charge to each identifiable service, whereas the indirect charge method allocates total service costs to entities in a related group using an allocation key designed to reflect the proportionate benefit received.

The CRA recognizes that conditions for the application of the direct charge method are not always present, and therefore the indirect method can be used when the value of a service provided to a number of non-arm’s length parties cannot be directly attributed to each of the parties. The CRA also supports the Organization for Economic Co-operation and Development (“OECD”) Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations which specify other situations where the indirect method may be appropriate.

The CRA noted that a management fee charge for intra-group services could include expenses that are not deductible for tax purposes in Canada under the provisions of the Income Tax Act (‘‘ITA’’), such as employee stock options, non-deductible reserves, club dues, donations, fines and penalties and others. These non-deductible items may be included in the intercompany charge and paid, but will not be deductible for tax purposes. CRA auditors will determine based on risk and materiality whether to request a breakdown of the items included in the management fee. The CRA also noted that subparagraph 152(4)(b)(iii) of the ITA extends the statute-barred period for an additional three years for reassessments of non-deductible expenses made as a consequence of non-arm’s length transactions between a taxpayer and a non-resident person.

Given the increased scrutiny by the CRA over the allocation of intra-group services, taxpayers should consult with their transfer pricing advisor regarding the current practice of charging these expenses.

Role of Multiple Year Data in Transfer Pricing Analyses
In TPM-16, Role of multiple year data in transfer pricing analyses, the CRA provides guidance on the use of multiple year data in determining the arm’s-length price. The CRA states that multiple year data should not be considered in evaluating the arm’s length price for a controlled transaction in a given year. The CRA emphasized its policy that the determination of arm’s length prices in a controlled transaction should be established each year with support from comparable transactions in the relevant tax year. This would generally be the year in which the controlled transaction took place. An exception is made for Advanced Pricing Arrangements (APAs), which often use historical data to benchmark a reasonable outcome for future years.

The memorandum clarifies that the use of interquartile range does not improve the comparability of a set of observations, therefore, suggesting that the full range of observations should be considered. Furthermore, the CRA prefers using the average results if the price or margin falls outside the established arm’s-length range.

Taxpayers should exercise caution in relying on multijurisdictional transfer pricing studies for the purpose of complying with Canadian contemporaneous documentation requirements, as such reports often use multi-year averages and interquartile ranges of comparable transactions to support a selected transfer price.


For additional information, please contact:

Jennifer Rhee
CPA, CA
Partner, Tax
T. 514.934.3552
jrhee@richter.ca


David Hogan
CPA, CMA, MA Economics
Partner, Tax
T. 416.785.1150
dhogan@richter.ca