Tax memo: Will your foreign-based transfer pricing documentation withstand CRA scrutiny?

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Memo No. 2013-07

If your foreign or U.S.-based parent prepares your Canadian transfer pricing (TP) documentation, how can you be sure it will meet Canada Revenue Agency (CRA) standards? A Canadian review will ensure that your documentation complies with Canadian guidelines and could even reduce issues arising on audit.

While preparing documentation from a global perspective is an effective process that allows for a consistent framework/message for all entities, foreign parents may focus their efforts on high-risk countries and transactions. This could leave Canadian-specific documentation at a level that might not meet the CRA’s “reasonable efforts” exception that allows you to avoid penalties in the event of a TP adjustment.

The CRA’s approach to TP documentation is different from that of many other tax authorities, including the Internal Revenue Service (IRS):

  • An unbundled approach is preferred; analysis is performed transaction-by-transaction.
  • The functional analysis is detailed, including a comprehensive description of the Canadian business; sometimes global documentation oversimplifies the functions performed by the Canadian entity, assuming that its operations are the same as in other countries.
  • A financial analysis is expected, with segmented results of the intercompany transactions that tie to the entity financial statements filed with the tax return; financial information used in foreign-based documentation may come from a centralized system and not reflect local entries (goodwill, amortization, purchase price accounting differences, etc.).
  • The CRA uses the full range of results rather than statistical measures like the interquartile range; results are reviewed on a year-by-year rather than weighted average basis.
  • A more precise selection of comparables is required, with the selection of the most comparable; these must be relevant to the North American market (i.e., not global).