Many manufacturers fail to appreciate the risk of double taxation that can accompany decisions about their foreign subsidiaries, for example decisions about how much management fees to charge the sub for management services provided by the parent or decisions about what the appropriate license fee should be for technology support provided to a sub.  

Taxation authorities everywhere, especially these days, want their fair share of the tax pie. CRA, for example, may be concerned that too little was charged to a sub in the U.S. by the Canadian parent company that, in deciding to keep the management fees charged to the sub at a low level, may have only been concerned with the foreign tax authorities.   But this decision will have an adverse income impact on the Canadian sub, causing it to pay less tax, and the CRA will have an interest in challenging the low fees assessed.

Managing a company’s transfer pricing issues can initially seem quite time consuming and complicated given the many rules (Section 247 of the ITA) and policies (IC 87-2R) that must be considered in non only one but both countries involved in the transaction.

As a minimum step and to reduce the potential for penalties, which can be significant at 10% of the income adjustment, every company should evaluate their related party transactions to determine whether under similar circumstances arm’s length parties would engage in a similar transaction for a similar price.   If you can’t, with a unbiased reply, say yes then there is an obvious problem that needs to be corrected.   If you believe that the transaction was established at a reasonable price, i.e. a royalty rate of 5% charged to your related party is the same charged to other unrelated licensees, than this information should be documented and retained for future use if audited.

CRA audit adjustments of a company’s intercompany pricing decisions will result in tax having been paid twice on the same income, once in each jurisdiction.   If a tax treaty exists with the other country relief can be obtained through a procedure called Competent Authority.   Competent Authority is a division within the government that will negotiate with other countries, the relief of double taxation for its residents.   More than 90% of the time this procedure is successful.   In contrast, domestically filed appeals will only result in relief where the adjustment is technically incorrect and double tax relief is not guaranteed.

For more information on transfer pricing visit the CRA’s website at  http://www.cra-arc.gc.ca/tx/nnrsdnts/cmp/menu-eng.html  or visit us at Gowlings at  http://www.gowlings.com/services/transferPricing.asp.