2013-0507381I7 Transfer pricing adjustments and gross revenue

Principal Issues: (1) How, if at all, is gross revenue to be adjusted when there is a transfer pricing adjustment when a Canadian resident purchases goods or services from a non-resident at an amount in excess of what would have been agreed to between persons dealing at arm's length? (2) How, if at all, is gross revenue to be adjusted when there is a transfer pricing adjustment when a Canadian resident sells a good or provides a service to a non-resident at an amount less than what would have been agreed to between persons dealing at arm's length? (3) In both scenarios, if gross revenue is to be adjusted, which permanent establishment would include it in its gross revenue?

Position: (1) A transfer pricing adjustment relating to an expenditure is not included in gross revenue; (2) A transfer pricing adjustment relating to revenue transactions is included in gross revenue; (3) Such an adjustment would be attributable to the whichever permanent establishment was reasonably attributed the gross revenue from the transaction that was subject to the transfer pricing adjustment.

Reasons: (1) Since the adjustment changes the amount considered to be paid for an expenditure, there is no effect on gross revenue; (2) Adjustments relating to sales revenue are included as they represent an amount that would have otherwise been received, which is captured by the definition of gross revenue under subsection 248(1); (3) The adjusted amount should be attributed to the original permanent establishment that was attributed the gross revenue for that taxation year.

Author: Deak, Andrew
Section: 402(3) ITR; 248(1) ITA; 247 ITA

                                                                                          September 1, 2015

    Provincial Legislative Affairs Section                            HEADQUARTERS
    Legislative Amendments Division                                 Income Tax Rulings
    Legislative Policy Directorate                                       Directorate
    Legislative Policy and Regulatory                                Andrew Deak
    Affairs Branch
    Attention:  Ron Kerr
                                                                                         2013-050738

    Gross revenue reasonably attributable to a permanent establishment in a province

We are writing in reply to Robin Maley’s email of October 7, 2013, in which she asked for our views on the impact of transfer pricing adjustments made under section 247 of the Income Tax Act (the “Act”) on “gross revenue” for the purposes of the provincial income allocation formula used in Part IV of the Income Tax Regulations (the “Regulations”). We apologise for the delay in responding. 

By way of background, Ms. Maley’s email outlined the mechanics of section 247. Specifically, it explained how transfer pricing adjustments are made when section 247 is engaged. Namely, where the terms or conditions of a transaction between persons not dealing at arm’s length differ from the terms or conditions that would have been made between persons who deal at arm’s length, the Canada Revenue Agency (CRA) can adjust the transaction price to the price that would have been negotiated if the transaction had been between persons dealing at arm’s length.

We have been asked to clarify the treatment of transfer pricing adjustments for provincial income allocation purposes in the following scenarios:

*    In the first scenario, a Canadian resident purchases a good (or service) from a non-resident at an amount in excess of what would have been paid between persons who deal at arm’s length. The additional expenditure by the Canadian resident results in an understatement of taxable income. For tax purposes, a transfer pricing adjustment is made to reduce the excess expenditure. In this scenario, should the CRA include the excess amount in the Canadian resident’s “gross revenue,” as defined in subsection 248(1)?

*    In the second scenario, a Canadian resident sells a good (or provides a service) to a non-resident at an amount less than what would have been paid between persons who deal at arm’s length. The reduced revenue to the Canadian resident results in an understatement of taxable income. For tax purposes, a transfer pricing adjustment is made to increase the amount considered to be paid to the Canadian resident. In this scenario, should the CRA increase the Canadian resident’s “gross revenue”, as defined in subsection 248(1)?

It was noted that, should any adjustment be included in gross revenue, it would be reasonably attributed either, in the first scenario, to the permanent establishment that made the payment that was subject to the transfer pricing adjustment, or, in the second scenario, to whichever permanent establishment was reasonably attributed the gross revenue from the sale that was subject to the transfer pricing adjustment. 

Our comments

Subsection 124(1) of the Act provides for an abatement of federal income tax payable by corporations. It takes the form of a deduction from the tax otherwise payable by a corporation equal to 10 percent of all of a corporation’s “taxable income earned in a year in a province”.  Subsection 124(4) states that the “taxable income earned in the year in a province” is the amount determined in accordance with the prescribed rules found in Part IV of the Regulations.

Subsection 402(3) of the Regulations applies where a corporation has a permanent establishment in a province and a permanent establishment outside that province.  Where this is the case, the corporation’s taxable income earned in the province is determined in part based on the proportion of the corporation’s gross revenue reasonably attributable to the corporation’s permanent establishment in the province to the total gross revenue of the corporation. 

Gross revenue is defined in subsection 248(1) of the Act as follows:

“gross revenue” of a taxpayer for a taxation year means the total of

(a)    all amounts received in the year or receivable in the year (depending on the method regularly followed by the taxpayer in computing the taxpayer's income) otherwise than as or on account of capital, and

(b)    all amounts (other than amounts referred to in paragraph (a)) included in computing the taxpayer's income from a business or property for the year because of subsection 12(3) or (4) or section 12.2 of this Act or subsection 12(8) of the Income Tax Act, chapter 148 of the Revised Statutes of Canada, 1952.

We were previously asked to clarify our position on the meaning of “gross revenue” and whether it includes volume discounts and rebates (2013-051492). It remains our view that gross revenue for the purposes of Part IV of the Regulations includes all amounts received or receivable by a taxpayer, other than on account of capital, but does not include amounts in respect of expenditures of the taxpayer. Below we apply this position to the two scenarios set out above. 

Application to scenario 1: adjustments relating to expenditures are not included in gross revenue for provincial income allocation purposes

This scenario arises because a Canadian resident pays more for goods or services than they otherwise would have, had the parties been dealing at arm’s length. Where the CRA applies subsection 247(2) to adjust those amounts, the adjustments change the price considered to be paid by the Canadian resident. Since the primary adjustment changes an amount paid, there is no amount that is received or receivable. Thus, an adjustment made as a result of an overpayment by the Canadian resident would not be included in gross revenue for provincial income allocation purposes.

Application to scenario 2: adjustments relating to an amount received or receivable for the sale of goods or services by a Canadian resident are included in gross revenue. 

This scenario arises because a Canadian resident receives less for goods (or services) than they otherwise would have had the parties been dealing at arm’s length. Where the CRA applies subsection 247(2) to adjust those amounts, the adjustment changes the amount the Canadian resident is considered to have received for purposes of the Act. 

As outlined above, for purposes of the Act “gross revenue” includes “all amounts received in the year or receivable in the year.” Upward adjustments made as per 247(2) essentially deem the sale price – an amount that was received or receivable – to be what it would have otherwise been had the parties been dealing at arm’s length. Therefore, the amount of the increase should be included in gross revenue for the year to which the adjustment is being made. Further, reading subsection 247(2) in the context of the section as a whole, it is clear that such adjustments should be included in gross revenue. In particular, we note that subparagraph 247(3)(b)(i) presumes that an adjustment made under 247(2) may have an impact on gross revenue.

We agree that any adjustment to gross revenue would be attributable (within the meaning of paragraph 402(3)(a)) to whichever permanent establishment was reasonably attributed the gross revenue from the sale that was subject to the transfer pricing adjustment. To be clear, the gross revenue would be adjusted for the year of the original transaction being subjected to the transfer pricing adjustment. 

For your information, unless exempted, a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Canada Revenue Agency’s electronic library. A severed copy will also be distributed to the commercial tax publishers, following a 90-day waiting period (unless advised otherwise to extend this waiting period), for inclusion in their databases. The severing process will remove all material that is not subject to disclosure, including information that could disclose the identity of the taxpayer. Should the taxpayer request a copy of this memorandum, they may request a severed copy using the Privacy Act criteria, which does not remove taxpayer identity. Requests for this latter version should be e-mailed to: ITRACCESSG@cra-arc.gc.ca. In such cases, a copy will be sent to you for delivery to the taxpayer.

We trust that this information is helpful.  If you have any questions regarding the above, please do not hesitate to contact us.

Terry Young, CPA, CA
Manager, Administrative Law Section
International Division 
Income Tax Rulings Directorate 
Legislative Policy and Regulatory Affairs Branch

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