5. Administrative Issues
Current Rules
5.1 Canada’s rules for international taxation are some of the most complex provisions of the Income Tax Act. Complying with these rules imposes a significant burden not only on Canadian businesses investing abroad and foreign investors doing business in Canada, but also on the CRA, which is responsible for administering the entire Act, including Canada’s international tax rules. Given the nature of cross-border transactions and the sophistication of modern businesses, some complexity is inevitable. Even still, every effort should be made to minimize the compliance burden imposed on taxpayers in the international arena.
5.2 This section reviews certain aspects of Canada’s international taxation system that give rise to specific concerns regarding process, administration and compliance.
Issues under the Current Rules
Transfer Pricing
5.3 “Transfer pricing” generally refers to the rules that govern the prices (for tax purposes) of goods and services between related parties in cross-border transactions. These rules are intended to ensure that prices charged for goods and services within the corporate group reflect market conditions rather than tax considerations, so the profit reported by a member of the group is close to the profit that would have been earned had that member been a stand-alone company. Canada’s transfer pricing rules embody the “arm’s length principle,” which asserts that transactions between persons not dealing at arm’s length (i.e., related parties) should reflect terms and conditions to which arm’s-length persons (i.e., unrelated parties) would agree. All OECD member countries have adopted this approach, and Canada has formally endorsed the OECD’s published guidelines on how the arm’s length principle should be applied.
5.4 As international trade rises, so do the number of cross-border transactions that are subject to the transfer pricing principles. It is possible that a move to a broader exemption system, as discussed earlier in this paper, may exert more pressure on the application and administration of the transfer pricing rules.
5.5 In 1998, Canada adopted new transfer pricing rules that added a requirement for contemporaneous documentation and increased penalties for failure to make reasonable efforts to estimate appropriate transfer prices. Given the importance of transfer pricing and the large dollar amounts that are often involved, it is appropriate to consult with businesses and the CRA on the effectiveness of administering these rules.
Foreign Parties Rendering Services in Canada
5.6 Canada’s tax law subjects payments made to residents of other countries for services rendered in Canada to withholding at a rate of 15 percent. The amount is withheld on account of a foreign party’s potential income tax liability in Canada, and it is reimbursed to the extent the foreign party is not taxable in Canada. A foreign service provider may apply for a waiver of withholding tax if the provider can show that the amount to be withheld exceeds the ultimate Canadian income tax liability.
5.7 While this withholding mechanism is intended to ensure compliance by residents of other countries that perform services in Canada, it may also be an obstacle to foreign service providers and to the Canadian companies that need their services.
Returns and Forms
5.8 In order to properly administer and enforce Canada’s international taxation system, the CRA needs to collect a great deal of information from taxpayers about their cross-border transactions.
5.9 Many returns and forms must be filed yearly by Canadian businesses and foreign companies doing business in Canada in respect of their cross-border activities.These returns and forms sometimes overlap, and the relevant information needed to determine the state of Canada’s income tax system may not be required to be reported.
Questions on Administrative Issues
- What issues commonly arise regarding the application of Canada’s transfer pricing rules? What measures could be implemented to improve the application of these rules?
- Are the transfer pricing rules being applied and administered in a balanced manner?
- Are penalties in the transfer pricing area being assessed fairly? Are the penalties appropriate?
- Is the current withholding tax requirement applicable to foreign service providers appropriate in light of compliance risks and the burden it imposes on foreign persons rendering services in Canada?
- What measures, if any, could be introduced to improve the waiver application process that is in place in respect of this requirement?
- What changes to existing returns and forms could be implemented to improve and streamline the existing international tax filing and information requirements?