Canada and U.K. propose arm's-length transfer pricing rules.

• Author: Patton, Michael F.

The Canadian government has proposed arm's-length transfer pricing legislation that would bring the country's transfer pricing rules in line with the July 1995 international transfer pricing guidelines of the Organization for Economic Cooperation and Development (OECD).

The proposed amendments would also impose documentation requirements and stiff penalties for taxpayers that failed to make reasonable efforts to document their transfer pricing practices. The arm's-length requirement, which would replace the current transfer pricing rules requiring related-party transactions to be based on what is a "reasonable amount" under the facts and circumstances, would apply to corporate taxpayers and partnerships for any transactions in tax years starting after 1997.

The proposed legislation would rely on the two types of arm's-length methods recommended by the OECD: (1) the traditional transaction methods (i.e., comparable uncontrolled price (CUP) method, resale price method and cost plus method); and (2) the transactional profit methods (i.e., the profit split and transactional net margin methods).

The Canadian government endorses the view of the OECD guidelines that the traditional methods are preferable to the transactional profit methods and that the latter should only be used as methods of last resort (i.e., when the use of traditional methods would not produce a reliable arm's-length price). If applicable, the CUP method is endorsed as providing the highest degree of comparability.

A de minimis rule protects taxpayers from the new provisions if the total fair market value of the properties or services involved in the tax year or reporting period does not exceed C$1 million.

Taxpayers would be required to prepare documents on all transfer pricing transactions within 60 days of the end of the tax year, and to provide those documents to Revenue Canada within 60 days of a written request to do so. The proposed legislation would create a penalty for failing to make reasonable efforts to determine and use arm's-length transfer prices in cross-border transactions. The penalty would apply when the total of a taxpayer's reduced transfer pricing income and capital adjustments for the year exceed the lesser of 10% of gross revenues for the year or C$5 million.

The penalty would be 10% of the amount of the "reduced" transfer pricing income and "capital adjustments." Much simplified, the penalty would be 10% of the pricing adjustment, rather than 10% of...