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In October 2004, the CRA issued a revised directive instructing field auditors to make formal, time-sensitive requests for a taxpayer's contemporaneous documents at the outset of an audit.
Effective immediately, all CRA field offices have been instructed to issue formal requests for transfer-pricing documentation to taxpayers at the initial stage of an audit and to enforce specific three-month periods for its provision. Such a request by a field auditor is mandatory: the previous directive, issued in March 2003, strongly suggested to the field offices that they obtain the transfer-pricing documentation at the start of an audit. This change in policy is intended to rectify a perceived inconsistency in the use of these letters by various CRA field offices and to increase transfer-pricing compliance.
Field auditors must request the contemporaneous transfer-pricing documentation in all cases in which transactions exist between a taxpayer and a non-resident that does not deal at arm's length with the taxpayer. The CRA will do no pre-screening to determine which taxpayers should receive this request letter, and no distinction is made between taxpayers by virtue of their size or level of revenue: all taxpayers can now expect to receive documentation request letters. This directive is part of the CRA's more assertive approach to transfer pricing; the new mandatory approach does not consider whether taxpayers have been cooperative and compliant in previous transfer-pricing audits.
The request for documentation, pursuant to subsection 247(4), may be in the form of a letter or a query sheet, but it must be either hand-delivered to the taxpayer or sent by registered or certified mail, and it should be made before the field work commences on the transfer-pricing audit. Taxpayers have three months from the date of the letter or query sheet to submit the documentation, with no provision for extensions. If a taxpayer fails to provide the contemporaneous documentation containing the required minimum information within the three-month period, then, for the purposes of the application of the penalty provision in subsection 247(3), the taxpayer is deemed not to have made reasonable efforts to determine and use arm's-length transfer prices. In general terms, a 10 percent penalty applies to the excess of transfer-pricing adjustments (for which the taxpayer did not make reasonable efforts to determine and use arm's-length transfer prices) over a threshold amount (the lesser of 10 percent of gross revenue and $5,000,000).
Three months is a relatively short period in which to respond to such demands for documentation: a taxpayer should regularly review existing documentation to ensure that it has prepared the documentation contemporaneously with the filing due date for the particular taxation year, thus forestalling possible penalties for failure to provide documentation in the event of a transfer-pricing adjustment.
Albert Baker
Deloitte & Touche LLP, Montreal
Gary Zed
Deloitte & Touche LLP, Ottawa
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