tax alert

Is it time to consider transfer pricing year-end adjustments?

Companies with a December 31 taxation year-end still have time to review their books and records to determine whether a year-end transfer pricing adjustment needs to be made.

Since the release of the Organization for Economic Cooperation and Development’s Base Erosion and Profit Shifting (OECD’s BEPS) Action 13 Report in 2015, tax authorities in more than 70 countries have implemented changes to transfer pricing compliance processes and procedures. Multinational enterprises (MNEs) today find themselves in a new landscape characterized by increased scrutiny.

Canada is no exception to this trend. When a Canadian MNE engages in cross-border intercompany transactions, Section 247 of the Income Tax Act requires that the intercompany prices used adhere to the arm’s length standard. It can be difficult even for well-intentioned MNEs to maintain arm’s length transfer pricing throughout the year. If non-arm’s length transfer pricing is reflected on the tax returns, the MNE may be subject to additional income taxes, penalties and interest.

To mitigate the risk of Canada Revenue Agency (CRA) scrutiny, a MNE should evaluate its intercompany transactions before the books close for the year, and document that process appropriately. If, pursuant to that evaluation, transfer prices are found to have materially strayed from the arm’s length principle, booking a “year-end true-up” or “adjustment” is recommended. The CRA recognizes that such adjustments may be necessary and in fact encourages them.

In our experience, common situations that prompt self-initiated year-end adjustments include circumstances where:

  • service charges for head-office/corporate support rendered on behalf of subsidiaries have not been made (e.g. management and administrative services);
  • service charges include only a recovery of compensation-related costs, but do not include a recovery of office/overheads, as the law requires;
  • charges have not been booked for direct expenses incurred by one entity on behalf of another (e.g. a shared umbrella insurance policy, or ERP system license);
  • charges for goods and services are calculated based on budgeted costs, rather than actual costs; and
  • profit mark-ups used in the pricing of goods or services are based on old benchmarks and have not been updated for the year, as the law requires.

Grant Thornton’s Transfer Pricing Group also regularly encounters questions from privately-held and publicly-listed multinationals connected to the issue of year-end transfer pricing adjustments. Frequent questions and areas of concern include:

  • Does cash need to be paid to settle a year-end adjustment?
  • Does there need to be a clause in the intercompany agreement allowing year-end adjustments?
  • Can a year-end adjustment cover multiple taxation years?
  • How do withholding and indirect tax impact year-end adjustments?
  • How do year-end adjustments affect customs/duty positions?
  • What is the best way to document year-end adjustments and how will they be scrutinized by the CRA?
  • How will the year-end adjustment be viewed from the perspective of the counterparty’s tax authority?

Our transfer pricing team is ready to help you navigate through relevant considerations regarding transfer pricing year-end adjustments, assess their impact and formulate a practical approach.