2016-0651411I7 Reassessment period – transfer pricing

Principal Issues: Whether subparagraph 152(4)(b)(iii) of the Act allows the Minister to issue an assessment, reassessment or additional assessment of tax under Part I beyond the normal reassessment period (i) to reattribute taxable income earned in a province with respect to a sale of goods to a non-arm’s length non-resident person, (ii) to increase gross revenue attributable to a province that results from a transfer pricing adjustment.

Position: Yes, to the extent that the assessment or reassessment reasonably relates to a transaction involving the taxpayer and a non-arm’s length non-resident person.

Reasons: An amount assessed or reassessed under Part I includes an assessment or reassessment of the deduction under section 124 of the Act. Such assessment or reassessment would include an assessment to reattribute taxable income earned in the year in a province as defined in subsection 124(4) of the Act and any Regulations prescribed for this purpose.

Author: Ouimet, Jennifer
Section: ITA: 152(4)(b)(iii); 152(4.01)(b)(iii); 247(2); 124(4); ITR: 402(3)

                                                                                                                                                         January 16, 2017

International and Large Business Directorate                                                                                  HEADQUARTERS
Large Business Audit Division                                                                                                          Income Tax Rulings
Provincial Income Allocation Section                                                                                                Directorate
                                                                                                                                                          J. Ouimet, CPA, CA
Attention: John Parker and Dan O’Neil
                                                                                                                                                          2016-065141

Reassessment period – transfer pricing

We are writing in reply to your request of June 6, 2016, regarding the extended reassessment period under subparagraph 152(4)(b)(iii) of the Income Tax Act (the “Act”). You ask whether subparagraph 152(4)(b)(iii) permits a reassessment with respect to the allocation of a corporation’s taxable income earned in a taxation year in a province, that results from a transfer pricing adjustment (“TPA”) made under subsection 247(2) of the Act.

Background

In your submission, you refer to our document 2013-050738 which opined that a TPA relating to a transaction involving a sale of goods is included in gross revenue, and that “any adjustment to gross revenue would be attributable…to whichever permanent establishment was reasonably attributed the gross revenue from the sale that was subject to the transfer pricing adjustment.” In this regard, you describe the following hypothetical situation:

A taxpayer, a Canadian corporation, sells in a taxation year goods to a non-resident with whom it is not dealing at arm’s length at an amount less than what would have been agreed to between persons dealing at arm’s length.

The taxpayer reports that it has two permanent establishments (“PE”), one in Ontario and one in Manitoba, as originally filed on its Schedule 5, Tax Calculation Supplementary - Corporations (“Schedule 5”) for the same taxation year. No provincial income allocation (“PIA”) audit was conducted during the normal reassessment period, and the taxpayer has not filed a waiver in a prescribed form within the normal reassessment period in respect of the year pursuant to subparagraph 152(4)(a)(ii) of the Act.

For the taxation year, a TPA is made under subsection 247(2) of the Act resulting in an increase in the amount of “gross revenue”, as defined under subsection 248(1) of the Act, in accordance with the views expressed in document 2013-050738. The TPA reassessment was made two years after the normal reassessment period ended.

Following the PIA audit conducted during the two years after the normal reassessment period, the following determinations were made:

*     The original amount of sale, which was reported on the taxpayer’s Schedule 5, relating to the Manitoba PE, and related TPA should have been reasonably attributable to the Ontario PE pursuant to paragraphs 402(4)(b) or (c) of the Income Tax Regulations (the “Regulations”), and

*     A third PE was identified in Quebec which would normally require a PIA audit adjustment to attribute a portion of taxable income to that province.

Based on the above hypothetical situation, you ask whether a reassessment of the taxpayer for the following reasons would be permitted:

*     to include the TPA in gross revenue, and attribute it to the Ontario PE under Part IV of the Regulations;

*     to reattribute the original amount of sale from the Manitoba PE to the Ontario PE under Part IV of the Regulations; and

*     to include a newly identified Quebec PE resulting from a PIA audit and allocate a portion of taxable income to that province under Part IV of the Regulations.

You provide the following comments in your letter:

Based on the position taken in Rulings document 2013-050738: “…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”, you suggest that subparagraph 152(4)(b)(iii) of the Act could possibly extend the normal reassessment period for the PIA adjustments, to permit an increase to the gross revenue allocated to the Ontario PE by the amount of the TPA.

In addition, you suggest that an argument can be made that the reallocation of the original amount of sale or taxable income reported on Schedule 5, from the Manitoba PE to the Ontario or Quebec PE, are derived from the PIA audit after the normal reassessment period and not as a consequence of the TPA. Consequently, in this case, it is your view that subparagraphs 152(4)(b)(iii) and 152(4.01)(b)(iii) of the Act would not extend the normal reassessment period for the PIA adjustments.

Our Comments

In general terms, subsection 247(2) of the Act requires that, for tax purposes, non-arm’s length parties conduct their transactions under terms and conditions that would have prevailed if the parties had been dealing at arm’s length with each other. In brief, under the transfer pricing rules in section 247 of Part XVI.1 of the Act, the Canada Revenue Agency (the “CRA”) will make adjustments, amongst other things, to amounts that a Canadian resident either paid to or received from a non-arm’s length non-resident person for goods or services. Where subsection 247(2) of the Act applies, any transaction amounts between non-arm’s length parties shall be adjusted to reflect the quantum or nature of the amounts that would have been agreed to between parties dealing at arm’s length.

Subsection 152(4) of the Act provides that the Minister may not assess or reassess tax payable under Part I after the normal reassessment period (as defined in subsection 152(3.1) of the Act) unless any of the exceptions described in subsection 152(4) apply. Subparagraph 152(4)(b)(iii) of the Act extends the normal reassessment period for a particular taxation year for an additional three years for reassessments made as a consequence of a transaction involving the taxpayer and a non-resident person with whom the taxpayer was not dealing at arm’s length. Furthermore, subparagraph 152(4.01)(b)(iii) of the Act limits the circumstances in which the Minister can reassess beyond the normal reassessment period only to the extent that it would reasonably be regarded as relating to such transaction. In this regard, it is necessary that there be a causal relationship between the transaction with a non-resident person with whom the taxpayer was not dealing at arm’s length and the amount assessed under Part I for that year.

Subsection 124(1) of the Act provides that there may be deducted from tax otherwise payable by a corporation under Part I for a taxation year an amount equal to 10% of the corporation’s “taxable income earned in the year in a province”, defined in subsection 124(4) of the Act to mean the amount determined under rules prescribed by regulations. In applying this definition for a corporation’s taxation year subsection 400(1) of the Regulations provides that

(a)   the rules in Part IV of the Regulations are the prescribed rules referred to in that definition; and

(b)   the amount determined under those prescribed rules means the aggregate of the taxable income of the corporation earned in the taxation year in each province.

Furthermore, pursuant to section 401 of the Regulations, Part IV of the Regulations applies to determine the amount of taxable income of a corporation earned in a taxation year in each province.

Subsection 402(3) of the Regulations applies where a corporation has a permanent establishment in a province and a permanent establishment outside that province and generally provides that the corporation’s taxable income earned in the year in a 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.

In our view, an assessment or reassessment under subsection 152(4) of the Act for a taxation year includes an assessment or reassessment to the deduction from tax otherwise payable under subsection 124(1) of the Act which includes the determination of taxable income earned in the year in a province as defined in subsection 124(4) of the Act and, by extension, the Regulations prescribed for this purpose. We recognize that an assessment or reassessment to reallocate taxable income earned in the taxation year in each province may not result in a change to the aggregate taxable income of the corporation for the taxation year and consequentially, Part I tax would likely be unaffected.

However, since Part IV of the Regulations applies to determine the amount of taxable income earned in a taxation year in each province, any changes made under this Part with respect to the allocation of taxable income earned in each province would likely impact the related provincial income tax to the extent that the tax legislation of a province adopts (or refers to) rules similar to those in Part IV of the Regulations, as well as rules similar to section 152 of the Act pertaining to assessments and reassessments. In this regard, it is our understanding that provincial income tax legislation includes such rules. We also recognize that the CRA administers the tax legislation for several provinces.

Accordingly, it is our view that under subparagraph 152(4)(b)(iii) of the Act the Minister may assess or reassess a taxpayer within 3 years after the normal reassessment period in respect of the computation of taxable income earned in the year in a province determined under Part IV of the Regulations for purposes of section 124 of the Act to the extent of any transaction involving the taxpayer and a non-arm’s length non-resident person. Such an assessment or reassessment includes the reattribution of gross revenue between provinces with respect to any transaction reported in gross revenue involving the taxpayer and a non-arm’s length non-resident person. In this regard, we consider a sale of goods by a Canadian corporation to a non-arm’s length non-resident person to be a transaction described in subparagraph 152(4)(b)(iii) of the Act.

In the hypothetical situation that you have described, pursuant to subparagraphs 152(4)(b)(iii) and 152(4.01)(b)(iii) of the Act, the Minister may reassess the taxpayer to reattribute the gross revenue originally reported by the taxpayer on Schedule 5 from the Manitoba PE to the Ontario or Quebec PE, as the case may be, under subsection 402(3) of the Regulations to the extent that such gross revenue reasonably relates to the sale of goods by the taxpayer to a non-arm’s length non-resident person. In addition, the Minister may reassess the taxpayer pursuant to subparagraph 152(4)(b)(iii) of the Act to increase gross revenue resulting from the TPA and reattribute such gross revenue increase to the Manitoba, Ontario or Quebec PE, as the case may be, under subsection 402(3) of the Regulations.

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: LPRA-PLAR ITR-DDI Access Team-Équipe d'Accès. In such cases, a copy will be sent to you for delivery to the taxpayer.

We trust our comments will be of assistance.

Bob Naufal
Manager
Administrative Law Section
International Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch

cc.  Ron Kerr, Acting Manager, Provincial Legislative Amendments Section
Legislative Policy Directorate

All rights reserved. Permission is granted to electronically copy and to print in hard copy for internal use only. No part of this information may be reproduced, modified, transmitted or redistributed in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, or stored in a retrieval system for any purpose other than noted above (including sales), without the prior written permission of Canada Revenue Agency, Ottawa, Ontario K1A 0L5.

© Her Majesty the Queen in Right of Canada, 2017

Tous droits réservés. Il est permis de copier sous forme électronique ou d'imprimer pour un usage interne seulement. Toutefois, il est interdit de reproduire, de modifier, de transmettre ou de redistribuer de l'information, sous quelque forme ou par quelque moyen que ce soit, de façon électronique, mécanique, photocopies ou autre, ou par stockage dans des systèmes d'extraction ou pour tout usage autre que ceux susmentionnés (incluant pour fin commerciale), sans l'autorisation écrite préalable de l'Agence du revenu du Canada, Ottawa, Ontario K1A 0L5.

© Sa Majesté la Reine du Chef du Canada, 2017