PLEASE NOTE: THIS INFORMATION WAS ORIGINALLY SUBMITTED BY COOPERS & LYBRAND, CANADA
The 1997 federal Budget tabled in Parliament maintained the "staying the course" theme with a continued decrease in the annual deficit. Over the past few years, Canada's deficit-to-gross domestic product ("GDP") ratio has moved from being one of the highest among the major industrialised nations to the lowest at 2.4% of GDP. By 1999 it is expected that, for the first time in 28 years, Canada will not have to go to the markets for new money for government programs or interest payments.
No tax increases were announced, however, some enhanced tax relief was outlined for selective groups such as lower-income parents, students and the disabled. Prior to the Budget speech, plans were unveiled that will begin changing the financing of the Canada Pension Plan from the current pay-as-you-go method to a fuller-funded plan with a reserve equal to five years of benefits.
The government used the occasion of the Budget to issue an outline of changes to Canada's transfer pricing provisions. Some of these proposals will require adjustments to the Income Tax Act and impose significant penalties for non-compliance. The announced changes will be effective for taxation years that begin after 1997. Those affected will want to initiate any necessary actions on a timely basis in order to ensure compliance with the new requirements.
The Canadian authorities have witnessed that the growth of international trade in recent years has meant a corresponding increase in the volume of goods, services and intangible property traded among related parties (i.e. parties that do not deal at arm's-length) that are situated in different countries. As a result of this growth, tax administrators around the world have focused more attention on the issue of international transfer pricing. A number of important changes affecting the way governments apply and enforce international transfer pricing rules have resulted. Canada will, therefore, be updating its current practices in the area of transfer pricing and will be introducing new documentation requirements and penalty provisions to ensure compliance.
Canadian transfer pricing law and Revenue Canada's administrative practices are based largely on principles and guidelines developed by the Organization for Economic Co-operation and Development ("OECD"). The OECD issued revised guidelines in 1995 which updated the international standard in this area. The basis of this standard is the "arm's-length principle", a yardstick used to ensure that prices charged between related parties on cross-border transactions correspond to those that would have been charged between unrelated parties. This standard is designed to protect the tax base against the shifting of income that could occur from the discretionary determination of transfer prices on transactions made between related parties situated in different countries. The adherence by all industrialised countries to a common standard should also prevent the double taxation of profits of multinational enterprises by two or more tax jurisdictions.
New guidance has been provided by the OECD regarding the nature and extent of the documentation of related-party transactions that can reasonably be expected to be available for the tax auditors. The issue of documentation is key since the determination and subsequent verification by tax auditors of transfer prices is a fact-sensitive matter. Some taxpayers neglect to adequately document their transactions with related parties or the basis upon which transfer prices are determined.
Canada has announced that it will pursue changes to its domestic tax law:
- to harmonise the Income Tax Act with the arm's-length principle as defined in the OECD guidelines and ensure that, in selecting the most appropriate pricing method, all the various methods described in the OECD guidelines are available to taxpayers;
- to ensure the "contemporaneous documentation" of cross-border related-party transactions, so that taxpayers are in a position to provide Revenue Canada, on a timely basis, the relevant information supporting their transfer prices; and
- to levy penalties against taxpayers that do not comply with the documentation requirements or do not act diligently in establishing transfer prices for their related-party transactions.
There currently is no official indication of the severity of the penalties - only that they will be "commensurate" with any transfer pricing adjustment. In the United States, Canada's principal trading partner, penalties can be as high as 40% of the adjustment.
All Canadian companies, partnerships, trusts, and individuals having business transactions with related non-residents should be computing their transfer prices using the "arm's-length principle" and have documentation available to support the amounts. To neglect this area will leave you exposed to challenge from the tax authorities and likely the imposition of significant penalties.
The information provided herein is for general guidance on matters of interest only. The application and impact of laws, regulations and administrative practices can vary widely, based on the specific facts involved. In addition, laws, regulations and administrative practices are continually being revised. Accordingly, this information is not intended to constitute legal, accounting, tax, investment or other professional advice or service.
While every effort has been made to ensure the information provided herein is accurate and timely, no decision should be made or action taken on the basis of this information without first consulting a Coopers & Lybrand professional. Should you have any questions concerning the information provided herein or require specific advice, please contact your Coopers & Lybrand advisor, or:
David W. Steele PricewaterhouseCoopers 145 King Street West Toronto, Ontario M5H 1V8 Canada Fax: 1-416-941-8415 E-mail: Click Contact Link
Click Contact Link