The Canadian government is taking a closer look at cross-border and domestic inter company transactions, and how they are priced. The importance of this is evident in the increasing number of audits taking place that scrutinize the inter company sale of goods, services and IP (management fees, trademarks, patents).

In brief, prices for inter company transactions should fit within a range of arm’s length amounts that are determined while looking at comparable transactions outside of the organization. The inter company transaction would have to be priced within this range to comply. There must be evidence of an attempt to price a transaction akin to what arm’s length parties would do. There is a requirement for documentation that supports these prices to be maintained on a yearly basis.

The typical transfer pricing report contains five parts. An overview of the business and inter company transactions; industry and market overview; function, risk and asset analysis (of the comparable transactions); identification of the most appropriate transfer pricing method (of five possible methods); and economic and financial analysis to determine the appropriate arm’s length price. The reports are specific to the type of transaction involved. Separate and distinct documentation must be maintained by both parties should inter company transactions be cross-border.

For Canadian income tax purposes, Form T106 must be filed with the corporate income tax return. This form discloses non-arm’s length transactions with non-residents (there are minimum threshold exemptions from this reporting). The form details the non-arm’s length transactions that took place during the fiscal year, the dollar amount involved, and how the “price” was determined. This Form asks if documentation is in place which effectively ensures that you comply with the standard on a yearly basis.

From a domestic standpoint, section 69 of the Income Tax Act allows the CRA to adjust inter company transactions if it determines the transaction was not “reasonable”. Inter company agreements that are in place with appropriate prices for all transactions can sometimes help to protect against possible adjustments.

Management fees for inter company services are a popular charge that appear on many statements. It is critical that there be written agreements in place for all fees charged; documenting who is doing the work and what work is involved. The fees charged must be akin to arm’s length amounts (it is important to determine this cost base since a “reasonable” mark-up is allowed), and services should actually be provided. The government will often look at what benefit was received by the party receiving the service. If no benefit is deemed to be received, the management fee will be disallowed.