Is the CRA skipping dinner in the hope of getting its deserts? Digesting the “new” Canadian transfer pricing documentation standard

Volume No. 16-05

The CRA was recently asked “Will the CRA’s expectations of the “reasonable efforts” that a taxpayer must make to determine and use arm’s length transfer prices include the preparation of transfer pricing documentation that is consistent with the recommendations from the OECD in Action 13 of the BEPS initiative (i.e. Master File and Local File transfer pricing documentation)?

This is a reasonable question to ask in view of the years of work of the Canadian government delegates to the OECD Base Erosion and Profit Shifting Project (BEPS), and the endorsement of the final BEPS Project Action 13 Report by the Government of Canada in the latest federal budget.  Perhaps some were expecting harmonization with the new international norm, or more precise guidance on how to avoid penalties than can be found in the current six bullet points in paragraph 247(4)(a) of the Income Tax Act and a smattering of guidance.  The response suggests something different altogether.

Answer: “The CRA considers that BEPS Action Item 13 has been dealt with by the introduction of proposed section 233.8 of the Act relating to Country-by-Country Reporting. The “reasonable efforts” requirement is based on the legislation contained in section 247 of the Act, in particular the requirement to produce “contemporaneous documentation” in accordance with subsection 247(4). Proposed section 233.8 has no direct relation to section 247 and does not include a specific requirement to produce a “local file” or “master file”. As such, the CRA has not altered its criteria regarding whether a taxpayer has made reasonable efforts to determine and use arm’s length transfer prices.

Like a quietly disappointed restaurant patron wishing to be left alone to finish her mediocre dish, the CRA was in effect asked how it was enjoying its meal of the OECD’s new transfer pricing documentation guidelines.  Its response suggests local file and master file requirements were too much of an acquired taste, and the CRA has now sent those items back to the kitchen.  The diner’s overall response of “Fine…” derives only from the great pleasure the Agency may expect from a dessert of Country-by-Country reports, and from being able to claim the OECD confection has been adopted and was a good choice for Canada.

The prospect of the empty calories from the Country-by-Country data tables must be too thrilling to risk filling the stomach with the main course, as many other tax authorities are learning to do.  (CbC reports, like desserts, contain relatively little nutritional value, and are only intended to look at for risk assessment purposes, not to make a meal of for easy reassessment calculations.)  A feast of taxpayer data and a maintained state of uncertainty keeps the playing field tilted in favour of the CRA.

Many foreign tax authorities have adopted the Action 13 report as a whole as well as other new transfer pricing principles, in line with the intentions of their finance ministers.  Many tax administrations have also taken on board the updated OECD Transfer Pricing Guidelines.  These tax authorities will require the master file from foreign subsidiaries of Canadian-parented companies as part of their documentation requirement.  It will be burdensome for Canadian taxpayers to have to produce more documentation than is ostensibly needed (and risk creating more than one set of facts when double tax cases arise).  An opportunity to mitigate the median taxpayer’s burden has clearly been passed up.  The “new” documentation burden will fall disproportionately on Canadian companies with worldwide net sales under $ 1 billion (approximately €750M at today’s exchange rate) that do not have to file a CbC report, but also do not have extensive tax departments.  These mid-sized and smaller companies must now contend with the compliance cost of the CRA double standard.

If the CRA can ignore adding parts of the BEPS Project transfer pricing reports  to Canadian transfer pricing rules (despite those additions being endorsed by the most recent federal budget), one might ask what will be ignored next.  The CRA has stated publicly that it already takes similar positions to those set out in writing in the various BEPS transfer pricing final reports, making it seem the international guidance is of diminished value in Canadian transfer pricing matters.  Will the CRA adopt the OECD Guidelines as updated by the BEPS project, or stick with the 2010 version it finally recognized in October 2012?  The historical approach suggests it is appropriate to avoid setting down the CRA position in writing for some time.  Perhaps the CRA is waiting for the U.S. Department of the Treasury to walk away from the BEPS Project consensus after Donald Trump enters office, is hedging its bets in anticipation of several Tax Court decisions, or is really more interested in penalties and reassessments than encouraging compliance.

Taxpayers that have wondered “How good is good enough?” when it comes to interpreting the Canadian documentation requirement will continue to be offered a diet of junk food by the CRA and asked to keep guessing.  Unfortunately for taxpayers, the real rules are off the menu and appear only when requested directly by professional tax advisors.  Taxpayers owe the Canadian Tax Foundation a debt of gratitude for this revelation.

Canadians are known the world over for many great traits, but in taxation are increasingly known for picking the luke-warm bowl of porridge.  The made-in-Canada approach (or compromise) is also a favourite.  Companies will need to carefully consider how to approach this particular tepid bowl of Canadian porridge.


TRANSFER PRICING NEWSLETTER is provided as a free service to clients and friends of Cadesky Tax. Tax laws are complex and are subject to frequent change. Professional advice should always be sought before implementing a tax planning arrangement or taking an uncertain tax filing position. Cadesky Tax cannot accept any liability for the tax consequences that may result from acting based on the contents hereof.