Canada - English

CRA Administrative Positions on Penalties and OECD Guidelines - by Rob Davis, Erin Sproule and Warren Novis 

Global Tax Adviser


December 11, 2012


Rob Davis, Erin Sproule and Warren Novis
Toronto, Transfer Pricing


The CRA has updated its administrative positions on referrals to its Transfer Pricing Review Committee and its use of the OECD Guidelines when performing transfer pricing audits. These positions are now reflected in two new transfer pricing memoranda (TPM), TPM-13, "Referrals to the Transfer Pricing Review Committee" and TPM-14, "2010 Update of the OECD Transfer Pricing Guidelines", which were published at the end of October 2012.

TPM-13 - Referrals to the Transfer Pricing Review Committee


The CRA's Transfer Pricing Review Committee (TPRC) must approve the application of transfer pricing penalties and reassessments based on Canada's "recharacterization" provisions. TPM-13, which replaces TPM-07 (issued in August 2005), discusses the specific referral procedures that taxpayers and the CRA must follow where either potential recharacterization or penalties may apply.


Recharacterizations - A recharacterization assessment arises where the CRA finds that a related-party transaction would not have been undertaken by parties dealing at arm's length. The CRA's assessment is based on its view of the way arm's-length parties would have structured the commercial arrangement. These assessments must be approved by the TPRC.


TPM-13 generally revises the communication process between the auditor and the TPRC to determine and assess a recharacterization proposal. TPM-13 clarifies that, if the initial referral to the TPRC is approved, the auditor must then carry out an in-depth examination to determine whether the facts support recharacterization.


Transfer Pricing Penalties - The CRA may assess transfer pricing penalties on an adjustment to income or capital that exceeds the lesser of $5 million or 10% of the taxpayer's gross revenue. If the TPRC finds that the taxpayer did not make reasonable efforts to determine and use arm's-length transfer prices for a given transaction, a transfer pricing penalty is assessed at 10% of the adjustment to income or capital.


The CRA generally provides a draft of its penalty referral report to the taxpayer at the proposal letter stage, so that the taxpayer can make its own representations to the TPRC. TPM-13 now clarifies that the CRA auditor will submit the taxpayer's representations, along with the penalty referral report, to the TPRC.


KPMG observations - While TPM-13 does not represent a significant update from TPM-07, certain words have been bolded, such as "before" and "must", or replaced (e.g., "should" with "will"), perhaps in an effort to consistently apply the TPRC process.


TPM-14 - 2010 Update of the OECD Transfer Pricing Guidelines


The OECD Guidelines (the Guidelines) are a constantly evolving set of guidelines prepared by the OECD to assist taxpayers and tax administrators in applying the arm's-length principle (Chapter I) to cross-border intercompany transactions. The 2010 update to the Guidelines focused on two key areas: transfer pricing methods (Chapter II) and comparability analysis (Chapter III), and business restructuring issues (new Chapter IX).


TPM-14 summarizes the major changes to Chapters I, II, III and IX of the Guidelines, and confirms that the CRA is adopting all of the changes to the Guidelines. Although the 2010 version of the Guidelines were made publicly available in July 2010, the CRA states that it will apply any new guidance contained in the Guidelines when administering the transfer pricing rules in Canada for any years under audit, because they merely clarify or elaborate on the application of the arm's-length principle that has historically been applied by the CRA.


Information Circular 87-2R, "International Transfer Pricing", the CRA's published administrative position on the implementation of transfer pricing legislation, was largely developed as a Canadian adoption of the 1995 OECD Guidelines. The TPM provides revised paragraph references for IC 87-2R to align it with the 2010 version of the Guidelines.


Methods and comparability

Hierarchy of methods - The Guidelines now contain a reorganized method selection to use "the most appropriate transfer pricing method", replacing a prior preference for a strict hierarchy where profit-based methods, such as the transactional net margin method (TNMM), were considered methods of a last resort. However, TPM-14 re-enforces the CRA's administrative position that traditional transactions methods, such as the comparable uncontrolled price (CUP) method, are preferable over profit-based methods where the methods can be applied in an equally reliable manner and the Guidelines should not be interpreted to change the methods' natural hierarchy.


Comparability - Chapter III of the Guidelines introduced a nine-step "typical process" for a comparability analysis. The CRA notes that, while this is good practice, this process is not compulsory. "Reasonable efforts" is a subjective test the CRA uses in the assessment of transfer pricing penalties. Taxpayers should consider whether their transfer pricing processes address key steps in Chapter III, such as evaluating internal comparables.


Business restructuring
Chapter IX on business restructuring is a brand new section not available to taxpayers prior to 2010. Hence, taxpayers' analyses for business transactions undertaken before 2010 may not fully address the factors specified in Chapter IX. For historic restructuring events, taxpayers should gather adequate facts, assumptions, forecasts, etc. and make an assessment based on the principles in Chapter IX.


For more information, contact your KPMG adviser.





Information is current to December 11, 2012. The information contained in this publication 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.