April 13, 2012
Transfer Pricing Adjustments May Trigger More Tax
Canadian businesses that have had their transfer prices adjusted by the CRA may face higher withholding tax liabilities due to measures proposed in the 2012 federal budget. Although these changes generally codify the CRA’s existing administrative position, they may also create a higher than expected non-resident withholding tax burden in certain situations, such as where the non-resident company involved in the transaction (e.g., a foreign sister company) is not a direct shareholder of the Canadian company.
Tax treatment of
Because the secondary adjustment is a deemed dividend and not an actual dividend, any Canadian withholding tax will generally not be eligible for a foreign tax credit in the other jurisdiction. However, the withholding tax applied to the deemed dividend may be reduced by a tax treaty.
Previously, there was ambiguity as to which treaty was relevant — the treaty of the parent company (who may direct the global intercompany arrangements) or the treaty of the other party to the transaction. The budget proposals clarify that the other party's treaty is the relevant one. Generally, this might result in higher withholding taxes, as the other party to the transaction (e.g., a foreign sister company) may not have sufficient share ownership in the Canadian entity to qualify for the most reduced treaty rate for dividends.
In addition, no deemed dividend will arise if the non-resident is a controlled foreign affiliate of the Canadian corporation. In this instance, the benefit conferred on the non-resident is more akin to a capital contribution than a dividend.
On repatriation of the amount of the primary adjustment, a secondary adjustment will be avoided. However, repatriation can create potential foreign currency exchange complications for both the payer and the recipient, as the exchange rates may have changed since the initial transaction.
Practical problems may also arise with repatriation, for example, if the original parties to the transaction have been wound up or sold to third parties.
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Information is current to April 12, 2012. The information contained in this TaxNewsFlash-Canada is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act upon such information without appropriate professional advice after a thorough examination of the particular situation. For more information, contact KPMG’s National Tax Centre at 416.777.8500.
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