What is transfer pricing?
Transfer pricing refers to the pricing of intercompany transactions between related parties within a corporate group. Transfer pricing can relate to the transfer of goods, services, and/or intangible property. Current transfer pricing legislation around the world tends to support the “arm’s length standard”.
What is the arm’s length standard?
The arm’s length standard requires that related parties transact with each other in a manner similar to how unrelated companies would interact. Accordingly, related party goods, services or intangible property should be transferred at valuations/prices that unrelated parties would use when transacting.
Why do taxation authorities care about transfer pricing?
Tax authorities care because intercompany pricing can have material impacts on the profit base of a local company within a corporate group. If the arm’s length standard is not followed, the taxation base of a given company would be distorted from its true profitability that likely would be achieved if it were only interacting with unrelated third parties. Obviously, taxation authorities want to ensure the tax bases of corporations are based on consistent principles throughout the world.
What are the obligations of a corporation with respect to transfer pricing?
Section 247 of the Income Tax Act requires all companies that file T106 forms to prepare contemporaneous documentation. A company must also disclose on their income tax filings whether they have prepared contemporaneous documentation. Contemporaneous documentation does not have to be filed with the annual tax return but it does have to be made available for the Canada Revenue Agency to review.
What is “contemporaneous documentation”?
“Contemporaneous documentation” refers to the preparation of documentation that is contemporaneous (or in conjunction with) the current tax year filings. For the purposes of Section 247, for a document to be contemporaneous, it should be substantially completed by the time the annual corporation tax returns are filed. Information Circular 87-2R outlines the requirements of your transfer pricing documentation.
What are the ramifications of not preparing contemporaneous documentation?
If the CRA later produces an adjustment under Section 247 and the company has not prepared contemporaneous documentation, the company will also be exposed to an additional penalty on the adjustment which is the lesser of 10% of the gross revenues or $5,000,000. The penalty would be applicable regardless of whether the corporation paid taxation in a given year.
Also, by not preparing any documentation, you are putting your company at a disadvantage. Going into a transfer pricing audit well prepared will increase your chances of successfully avoiding an adjustment whereas not producing sufficient (or any) documentation may result in increased exposure.
What should be included in our contemporaneous documentation?
Paragraph 187 of Information Circular 87-2R outlines the requirements expected to be within your company’s contemporaneous documentation. The CRA expects all six bullet points to be addressed.
Does my documentation require a benchmarking study?
This will depend on the methodology you have chosen to support your documentation. Velorum can assist you with determining the most appropriate analysis you should include in your documentation.
Do I have to file my documentation with my corporate tax return?
No, you do not but your documentation should be available for CRA if you receive a 90-day request letter.