Tuesday, 17 April 2012

Proposed Canadian Transfer Pricing Amendments

The March 29, 2012, Canadian fiscal budget contained transfer pricing-related amendments to the Income Tax Act. Previously, transfer pricing adjustments made by the Canada Revenue Agency (“CRA”) resulted in a constructive or deemed dividend as a result of the benefit conferred to the non-resident parent company by its Canadian subsidiary company. That is, when a Canadian subsidiary receives an income or capital transfer pricing adjustment, the CRA “deems” the non-resident parent to have received a dividend equal to the amount of this primary adjustment. The deemed dividend, or secondary adjustment, is subject to withholding tax of 25 percent. Tax treaties typically reduce this withholding tax rate (e.g., the Canada-US tax treaty reduces the rate to 5 percent). The budget proposes to treat the benefit from the primary adjustment as a deemed dividend irrespective of whether the non-resident is a shareholder of the Canadian corporation.

Previously, under certain conditions, an administrative practice of the CRA allowed the elimination of the deemed dividend if the amount of the primary adjustment was repatriated to the Canadian Corporation. The budget proposes to codify this administrative practice into legislation. These proposals will apply to transactions that occur on or after March 29, 2012.

In addition, thin capitalization rules would be amended under the new fiscal budget. These rules address the deductibility of interest payments a Canadian resident pays to certain non-residents for debts owing that exceed twice the amount of the corporation’s equity. The budget proposes to reduce the debt-to-equity ratio from 2-to-1 to 1.5-to-1. This change would apply to corporate taxation years that begin after 2012.

Source: Ceteris Transfer Pricing Times Volume IX, Issue 4‏