Transfer Pricing Memorandum (TPM)-17 states that when a Canadian taxpayer receives government assistance and participates in a cross-border controlled transaction, it should not share all or part of that assistance with non-arm's length non-resident persons. This policy is meant to prevent Canadian government assistance from being used to benefit a party outside of Canada which would not have been able to directly apply for the assistance, such as a foreign parent. But, since this guidance is not the law and COVID-19 government assistance can be quite material, it can be tempting for multinational groups to share the assistance among the related group. If that is done, pushback from government should be expected and planned for.
Consider a Canadian company (CanCo) that performs research and development (R&D) in Canada for its foreign parent. CanCo incurs costs of $100. CanCo’s policy is to charge the parent the total cost of this work plus a mark-up of 10% on these costs. The issue is how to treat COVID-19 government assistance of $20 received in 2020 in determining the chargeback price to the foreign parent. The $20 could be received in various forms: administrative concessions, payment deferrals, loans, and subsidies or grants.
One method is to follow TPM-17 and ignore this assistance in determining the allocable costs (that is – the costs charged by a Canadian taxpayer to the non-arm's length non-resident person for the provision of services or sale of goods). In that case, Canco’s taxable income would be $30 ($100 x 1.1 + $20 - $100). Another approach would be to reduce its allocable costs or mark-up by the amount of this assistance. Assuming CanCo reduces its allocable cost, its taxable income would be $8 (($100 - $20) x 1.1 + $20 - $100). Alternatively, CanCo could reduce the mark-up to, for example 5% of costs it incurred, if so, its taxable income would be $25 ($100 x 1.05 + $20 - $100).
The CRA has not specifically indicated that TPM-17 will apply to COVID-19 government assistance, but it is clear that the general policy is that such assistance should not be directly or indirectly shared abroad. The CRA has noted that taxpayers engaging in tax evasion or avoidance schemes that attempt to exploit the crisis can expect the CRA to pursue all compliance tools at its disposal to protect the integrity of Canada's tax system.
Where a Canadian taxpayer plans to directly or indirectly share all or part of the COVID-19 government assistance with a non-arm's length non-resident person by way of reducing its allocable cost or mark-up, it should perform an in-depth economic analysis to develop support for this approach. In other words, it should have documentation that shows that the prices charged reflect arm’s length prices and are not merely a mechanical application of a cost-plus formula. These analyses have been challenging historically, and given the current economic crisis, their importance cannot be understated. Failure to perform a proper economic analysis could result in penalties under the respective COVID-19 government assistance program and possibly also increase income tax obligations and penalties under section 247.
This article was first published by the Canadian Tax Foundation in Canadian Tax Focus, July 2020.
