Cross-border Tax Disputes Cost Billions

Chrysler Talks Highlight Huge Costs of Tax Disputes to Canadian Business

Written By Claire M.C. Kennedy and Darrel H. Pearson

Recent media reports that Chrysler's $1-billion transfer pricing dispute with Canadian tax authorities is jeopardizing the company's restructuring negotiations highlight the enormous cost of tax disputes to business and illustrate the critical importance of effective management of tax disputes.

A number of key factors can drive up the costs of corporate income and commodity tax disputes relating to cross-border intercompany pricing, which is an increasingly high priority enforcement area for Canadian tax and customs authorities (the Canada Revenue Agency and the Canada Border Service Agency, respectively).

Extended Statute of Limitations

The Income Tax Act (Canada) legislation almost doubles the normal income tax reassessment period for transfer pricing disputes, extending it from four to seven years for most corporate taxpayers. This can significantly impact the overall cost to a taxpayer as a consequence of allowing the CRA additional audit time to raise issues while simultaneously impairing the taxpayer's ability to fight a reassessment (through loss of records or personnel over time) and adding substantial interest cost to a final reassessment. The Customs Act allows for reassessment of customs duties, GST, and interest on cross-border transactions for up to four years.

Penalties

The Income Tax Act provides for a mandatory 10- percent cash penalty if the CRA's transfer pricing adjustment exceeds a statutory threshold and the taxpayer did not make “reasonable efforts” to determine and use arm's length transfer prices. Separate and additional penalties are exigible by the CBSA for failing to reflect the results of transfer pricing studies/policies and/ or advance pricing agreements in adjustments to importation entries.

Under the Income Tax Act, a taxpayer is deemed not to have made the requisite reasonable efforts unless the taxpayer has complied with the so-called “contemporaneous documentation” requirement. This is not a “saving rule”. Even if a taxpayer prepares extensive documentation, it does not mean that the taxpayer is deemed to have complied with the reasonable efforts requirements. It only means that the taxpayer is not deemed not to have done so—and only then if the CRA actually accepts the documentation as meeting the standard and it is delivered within three months of the CRA's request. The CRA is routinely insisting on the three-month deadline without extension.

Whipsaw with Foreign Tax Authority

In theory, the determination of an arm's length transfer price between a Canadian taxpayer and a related non-resident entity should be a zero-sum process involving the CRA and the relevant foreign tax authority. Any upward adjustment by either tax authority should be matched by a corresponding downward adjustment by the other. In practice, taxpayers may be “whipsawed” if the two tax authorities refuse to make reciprocal adjustments, resulting in double taxation. Recent changes to the Canada-U.S. Income Tax Treaty are intended to deliver relief through a mandatory arbitration proceeding for the CRA and the IRS, but that process is untested and likely to be slow.

Whipsaw with Canadian Customs Valuations

An often overlooked peril for taxpayers in the cross-border pricing of goods is the potential whipsaw between transfer prices under the Income Tax Act, administered by the CRA, and the price paid or payable for goods (value for duty) under the Customs Act, administered by the CBSA. The transfer price and value for duty tend to have an inverse relationship (e.g., increased cost of inputs reduces Canadian profits for income tax purposes but represents increased value for duty). In theory, both transfer prices and value for duty should reflect arm's length pricing, but, in practice, the CRA and CBSA may adopt different approaches to valuation. Indeed, under current CBSA policy, taxpayers are not permitted to amend entries and reduce values for duty (and hence customs duties and GST) if there is a downward adjustment to a transfer price, even if the adjustment is required to comply with transfer pricing rules.

Bennett Jones trade lawyers are currently representing a Canadian affiliate of a major multinational manufacturing enterprise caught in just such a “whipsaw” situation and are challenging the legality of the CBSA policy.

Bennett Jones counsels clients in all aspects of corporate income and commodity tax disputes. Our partners are recognized as leading practitioners in the areas of transfer pricing, corporate taxation, corporate tax litigation and international trade by Lexpert, Euromoney Legal Media Group's Guide to the World's Leading Transfer Pricing Lawyers and Chambers Global: The World's Leading Lawyers for Business. We have significant experience representing taxpayers on major cross-border pricing disputes and are pleased to discuss with you how Bennett Jones can help your business better manage cross-border pricing risk.