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TPM-03R

Downward Transfer Pricing Adjustments

June 21, 2022

Application

Transfer pricing memoranda (TPMs) are issued periodically to communicate the Canada Revenue Agency’s (CRA) transfer pricing policy and provide guidance on specific aspects of the transfer pricing legislation. While the content of this memorandum relates to provisions of the law in force at the time it was written, the information provided is not a substitute for the law. Since this memorandum may not address your particular situation, you should refer to the Income Tax Act, any applicable regulation, and relevant case law. For more information, you can contact the Competent Authority Services Division (CASD) by email at CPMAPAPAG@cra-arc.gc.ca or contact a CRA tax services office (TSO). Please do not send taxpayer-specific information to this email address.

Introduction

1. This memorandum cancels and replaces Transfer Pricing Memorandum TPM 03, Downward Transfer Pricing Adjustments under Subsection 247(2), dated October 20, 2003. The policies included in this memorandum are effective as of the date of this publication.

2. The purpose of this memorandum is to provide guidance on how downward transfer pricing adjustments should be directed. For the downward transfer pricing adjustments that should be directed to a TSO, this memorandum also provides guidance on how they will be managed. All downward transfer pricing adjustments that should be directed to CASD will be managed in accordance with current version of Information Circular IC71-17, Competent Authority Assistance Under Canada’s Tax Conventions.

3. The information provided in this memorandum is not intended to be exhaustive, and is not meant to restrict the spirit or intent of the legislation.

Background

4. Subsection 247(2) of the Income Tax ActFootnote 1 (Act) applies to a transactionFootnote 2 or a series of transactions:

  1. involving a taxpayer and a non-resident person (or a partnership of which the non-resident person is a member) with whom the taxpayer does not deal at arm's length; or
  2. involving a partnership or a member of a partnership and a non-resident person with whom the partnership or member does not deal at arm's length (or a partnership of which such a non-resident is a member). Footnote 3

5. Generally, subsection 247(2) provides for the adjustment of amounts that would be determined for the purposes of applying the provisions of the Act to the quantum or nature of the amounts that would have been determined had the parties been dealing at arm’s length.

6. A downward transfer pricing adjustment includes any adjustment under 247(2) that reduces the income, increases the loss, or increases capital expenditures, of the taxpayer, or would have that effect, if it were the only adjustment made under subsection (2). Various examples of different downward adjustment situations are set out in Appendix A.

7. Subsection 247(10) places a limitation on any downward transfer pricing adjustment; specifically, the adjustment cannot be made unless, in the opinion of the Minister, the circumstances are such that it would be appropriate that the adjustment be made. Under subsection 220(2.01), the Minister authorizes an officer or class of officers to exercise powers or perform duties of the MinisterFootnote 4. The Director of the International Tax Division (ITD) and the Assistant Director of Audit, among others, have been delegated the authority to determine the appropriateness of an adjustment for the purposes of subsection 247(10)Footnote 5. In practice, the delegated authority is generally exercised by these officials. Downward adjustments are also considered by the Competent Authority Services Division in certain cases.

8. Downward transfer pricing adjustments are not intended to serve as a vehicle for taxpayers to implement retroactive tax planning or base erosion and profit shifting strategies, nor are they intended to achieve double non-taxation.

9. Downward transfer pricing adjustments involving either a treaty or non-treaty country can be a result of:

  1. A taxpayer request independent of a transfer pricing audit;
  2. A taxpayer request as a result of an upward adjustment initiated by a foreign tax authority;
  3. A taxpayer request during the course of a transfer pricing audit; or
  4. An adjustment initiated by a CRA auditor during the course of a transfer pricing audit.

Policy

a) Where to send a request

10. Where a taxpayer requests a downward transfer pricing adjustment in Canada, that is independent of a transfer pricing audit, or as a result of an upward adjustment initiated by a foreign tax authority, the taxpayer should send the request to the Director of the CASD in accordance with the guidance set out in IC 71-17.

11. Where a taxpayer requests a downward transfer pricing adjustment in Canada for a tax year currently under a transfer pricing audit, and the request does not relate to an upward adjustment initiated by a foreign tax authority, the taxpayer should send the request to the TSO conducting the audit.

12. As outlined in the above-noted information circular, the CASD will accept a request under the Mutual Agreement Procedure (MAP) that involves a request for a downward transfer pricing adjustment only in the following circumstances:

  1. A corresponding upward adjustment has been accepted for consideration by the foreign tax authority;
  2. The foreign competent authority takes steps to resolve the case under the MAP by reviewing the case, providing the Canadian competent authority with a detailed analysis as to why the foreign authority agrees with the adjustment and agrees to negotiate the case;
  3. The request for competent authority assistance is made within the time limits of the applicable treaty; and
  4. The issue is not one that the Canadian competent authority has decided, as a matter of policy, not to consider.

13. When a downward transfer pricing adjustment in Canada involves a transaction in a non-treaty country and relates to a taxation year not currently under a transfer pricing audit, the taxpayer should still send the request to the CASD.

b) Audit review

14. For tax years subject to a transfer pricing audit in progress, the CRA will review downward adjustment requests to determine if the circumstances are such that it would be considered appropriate that the adjustments be made.

15. If the taxpayer cannot demonstrate to the CRA’s satisfaction the absence of retroactive tax planningFootnote 6, base erosion and profit shifting strategies, or double non-taxationFootnote 7, the auditor will complete their review, document their findings, and recommend the request not be accepted by the relevant delegated authorityFootnote 8.

16. The level of review conducted by auditors should be commensurate with the existence of evidence of the above-noted factors. Should further review be warranted, auditors would then consider whether the downward adjustment would represent an acceptable application of the arm’s length principle.

17. In general, in order to prevent complications that may arise in dispute resolution processes (such as an objection or MAP), the auditor will consider a downward transfer pricing adjustment that involves a transaction in a treaty country only in the following circumstances:

18. For a downward transfer pricing request that involves a transaction in a treaty country that does not meet the conditions in paragraph 17, the auditor will review the request, verify facts, as needed, and complete a recommendation reportFootnote 11 for the Director of the CASDFootnote 12. Even in situations where an auditor recommends a downward request be denied, taxpayers may still be eligible for a MAP. That said, such a report would not constitute a MAP request, and it is the responsibility of the taxpayer to submit a MAP request to the CASD directly.

19. Upward transfer pricing adjustments can sometimes be reduced after an audit by way of an objection or appeal. This may result in a downward transfer pricing adjustment that exceeds the ultimate upward audit adjustment, which will lead to double non-taxation. To resolve this, where a downward adjustment is closely linked to an upward audit adjustment, the CRA will seek an audit agreement and waiver of appeal rights that includes both the upward and downward adjustments.

20. In certain situations, auditors may be required to assist the CASD by reviewing requests for downward transfer pricing adjustments involving transactions in non-treaty countries. In these situations, auditors can follow the guidelines in this TPM as they apply to the particular situation.

c) Authorization of a downward transfer pricing adjustment at the audit stage

21. As noted above, under subsection 220(2.01), the Director of the ITD and the Assistant Director of Audit have been delegated the authority to determine the appropriateness of an adjustment for the purposes of subsection 247(10). Therefore, once auditors have completed their review of a potential downward adjustment, they must prepare a referral seeking approval of the delegated authority. For files under audit that have a downward transfer pricing adjustment of less than $10,000,000, the referral must be made by the auditor to their respective Assistant Director of Audit. For files under audit that have a downward transfer pricing adjustment of $10,000,000 or greater, the referral must be made by the auditor to the Director of the ITD.

22. In order to determine the appropriate delegated authority, transfer pricing adjustments are calculated on a year by year basis and separately for each non-arm’s length non-resident with whom the Canadian taxpayer deals.

23. Situations may arise where one downward transfer pricing adjustment should be referred to the Assistant Director of Audit and another to the Director of the ITD on the same file. In this type of situation all referrals will be made to the Director of the ITD, to ensure consistency.

24. Referrals should be made after sending the audit proposal letter but prior to sending the letter finalizing the file with the taxpayer. They should include the amounts and taxation years involved, the parties involved and their relationship, a general description of the facts, taxpayer representations, steps to be taken by the taxpayer with respect to repatriation and a recommendation as to whether or not the adjustment should be considered appropriate and why. See Appendix B for the referral template.

25. The taxpayer should be informed that the downward transfer pricing adjustment must be referred to the Assistant Director of Audit or the Director of the ITD for consideration of its appropriateness. The taxpayer should also be made aware of whether the auditor is or is not recommending that the adjustment be either wholly or partially allowed. Once the delegated authority has made their decision, the taxpayer will be notified.

d) Repatriation

26. Where a Canadian taxpayer is requesting an increase in the transfer price of purchases or acquisitions without repatriation, there is an increased expense or cost without an outlay. Furthermore, where a Canadian taxpayer requests a decrease in the transfer price of sales to a non-arm’s length non-resident without repatriation, the Canadian taxpayer has turned an otherwise taxable receipt of money into a non-taxable amount. Therefore, in order for a downward transfer pricing adjustment to be considered appropriate, repatriation must be carried out within 90 days of signing a repatriation agreement (see Transfer Pricing Memorandum TPM-02R, Secondary Transfer Pricing Adjustments, Repatriation and Part XIII Tax Assessments).

27. Repatriation can be accomplished by offsetting against a separate upward transfer pricing adjustment that relates to the same non-arm’s length non-resident, for the same tax year. Where there are no upward transfer pricing adjustments to offset the downward adjustment, the repatriation payment must be carried out as outlined in TPM-02R, taking into account that it is the Canadian taxpayer returning the funds in this case.

28. There may be cases where the taxpayer requests an increase to an expense on a transaction that was previously subject to Part XIII withholding tax. It would not be appropriate to offset this with another upward transfer pricing adjustment that was not previously subject to Part XIII withholding tax. The downward transfer pricing adjustment amount would need to be repatriated separately so the applicable Part XIII tax could be levied on the downward adjustment.

Conclusion

29. As noted above, downward transfer pricing adjustments are not intended to serve as a vehicle for taxpayers to implement retroactive tax planning, or base erosion and profit shifting strategies, or to achieve double non-taxation.

30. Downward transfer pricing adjustments are only available in limited circumstances. Where the request involves a treaty country, downward transfer pricing adjustments will only be applied at the audit stage to the extent that they are closely linked to, and do not exceed, the upward transfer pricing adjustments.

31. There are CRA established programs for taxpayers who wish to have tax certainty in their non-arm’s length cross border transactions. These programs include the International Transfer Pricing: Advance Pricing Arrangements (Information Circular IC 94-4R), Advance Pricing Arrangements for Small Businesses (Information Circular IC94-4RSR), Advance Pricing Arrangement Rollback (TPM-11), and Accelerated Competent Authority Procedure (TPM-12). Taxpayers may still qualify for a MAP in situations that involve a transaction in a treaty country even if the downward transfer pricing request does not meet certain policy requirements listed in this memorandum. Please see IC 71-17 for eligibility criteria and details on how to request a MAP. Taxpayers are encouraged to utilize the programs in place to ensure that their transactions are in accordance with the arm’s length principle and to obtain tax certainty.

Appendix A – Examples

1. A taxpayer requests downward transfer pricing adjustments relating to the 2013 to 2019 taxation years. The taxpayer is currently under a transfer pricing audit for the 2015 and 2016 taxation years. The taxpayer’s request for the tax years that relate to the audit period should be directed to the TSO. The taxpayer’s request that relates to tax years outside the audit period should be directed to the CASD.

2. A Canadian corporation requests a $1 million downward transfer pricing adjustment. The request is based on the result of a recent audit of its non-resident parent by the tax authority of the country in which the parent company resides. This is a country with which Canada has a tax treaty. In such a situation, the taxpayer should be referred to the Director of the CASD. The taxpayer should refer to the most recent version of IC 71-17.

3. A transfer pricing audit results in the following transfer pricing adjustments: Year 1 increase/upward, and Year 2 decrease/downward. Under this scenario, processing the downward adjustment for Year 2 would result in double non-taxation. This would be a negative factor in determining if the adjustment is appropriate. The taxpayer has the option of reporting the Year 2 income in the other jurisdiction and, where Canada has a tax treaty with that jurisdiction, the double taxation can be resolved through the MAP, as will be the case with the year 1 upward adjustment.

4. The taxpayer submits a request for a downward transfer pricing adjustment based on a new transfer pricing study. The non-arm’s length non-resident entity reports the corresponding increase in the other jurisdiction after undergoing a corporate reorganization in that other jurisdiction. The reorganization resulted in the non-arm’s length non-resident having significant losses which would absorb the corresponding increase to income. This may be considered base erosion and profit shifting and retroactive tax planning and may not be considered appropriate in the opinion of the Minister.

Appendix B – Downward Transfer Pricing Adjustment Referral

ADDRESS

A. Taxpayer name

B. Name of related non-resident and country

C. Relationship to non-resident

(parent, subsidiary, sister company)

D. Years involving downward transfer pricing adjustments

E. Basis for downward transfer pricing adjustments

(i.e. transfer pricing study, foreign audit, taxpayer request etc. Referrals should include supporting material.)

F. General description of the facts

(outline 247(2) primary adjustment including amount, the taxation year and dollar amount of downward adjustment.

G. Taxpayer representations

(including the steps to be taken by the taxpayer with respect to repatriation, if applicable)

H. Outline work carried out to evaluate appropriateness of downward transfer pricing adjustment

I. Recommendation

J. Name and signature of the International and Large Business Case Manager/International Specialty Audit Team Leader, and the International Tax Auditor

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