Where the rules apply, the consequences are as follows:
The transfer pricing rules apply to Canadian residents and to non-residents carrying on business in Canada; therefore, these rules are potentially relevant to both Canadian subsidiaries (and parent companies) and Canadian branches. The pricing of goods and the quantum of management fees, guarantee fees and royalties are common matters for transfer pricing scrutiny. Where a Canadian taxpayer or a partnership participates in one or more transactions with a non-arm’s-length non-resident and either (i) the terms of the transactions differ from those that would have been made by arm’s- length persons or (ii) the transactions cannot reasonably be considered bona fide transactions entered into for non-tax purposes and would not have been entered into by arm’s-length persons, then the CRA can make adjustments under the transfer pricing rules in the Tax Act, including imputing income or denying deductions. In addition, penalties can be levied. Where a taxpayer’s transfer pricing adjustments for a year exceed the lesser of $5 million and the taxpayer’s gross revenue for the year computed in accordance with the Tax Act, a penalty equal to 10% of the total transfer pricing adjustments applies unless reasonable efforts were made to apply arm’s-length terms. For these purposes, a taxpayer will be deemed not to have made reasonable efforts to apply arm’s-length terms unless the taxpayer makes or obtains complete records of the transactions establishing the appropriateness of the transactions from a transfer pricing perspective no later than the taxpayer’s tax return due date (or in the case of a partnership, its annual information return due date). This rule is often referred to as the contemporaneous documentation requirement.
– The Canadian corporation is deemed to have paid, at the time it acquires the investment in the foreign subsidiary, a dividend to the foreign parent for withholding tax purposes in an amount equal to the fair market value of any non-share consideration paid by the Canadian corporation for such acquisition (the deemed dividend can be eliminated and replaced with a reduction of paid-up capital in certain circumstances). – No amount will be added to the Canadian corporation’s tax paid-up capital in respect of any shares issued by the Canadian corporation in consideration for the acquisition of the investment in the foreign subsidiary. This will prohibit any addition in the equity component of the debt-to-equity thin capitalization ratio and will impede the ability to extract assets from Canada on a tax-efficient basis in the future. – No amount will be reflected in the contributed surplus of the Canadian corporation as a result of the acquisition of the investment in the foreign subsidiary for the purposes of (i) the debt-to-equity thin capitalization ratio; and (ii) the rules allowing for a conversion of contributed surplus to tax paid-up capital without triggering a deemed dividend. TRANSFER PRICING RULES Canada, like many other countries, employs transfer pricing rules to protect its tax base. The rules are designed to ensure that the income of Canadian taxpayers (and their corresponding Canadian tax liability) is not artificially reduced through non-arm’s- length transactions with related non-residents.
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Doing Business in Canada
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