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How should employers consider Canada’s Emergency Wage Subsidy in setting their transfer prices?
As of September 13, 2020, close to 1.1M Canadian employers had applied for the Canada Emergency Wage Subsidy (“CEWS”) to cope with the effect of the Covid19 pandemic and the subsequent lockdown. This wage subsidy is available for Canadian companies that experienced significant decrease in revenues since March 2020.
According to the most recent version of the CEWS, Canadian employer can be eligible to the wage subsidy if the decrease in their qualifying revenue meet the required threshold for the period, even if all or substantially all of their revenues are from sales to a non-resident corporation, who then sells to arm’s length customers.
Consequently, it is important for these Canadian eligible employers to understand how to treat the wage subsidy for transfer pricing purposes.
TPM-17: CRA’s Position on the Treatment of Government Assistance for Transfer Pricing Purposes
CRA’s position on the treatment of government assistance in the context of a transfer pricing analysis is described in a transfer pricing memorandum (TPM-17) that was published back in March 2016.
According to TPM-17, when a taxpayer receiving governmental assistance uses a cost-based transfer pricing methodology to determine the transfer price of goods, services, or intangibles sold to a non-arm’s length non-resident person, the cost base should not be reduced by the amount of the government assistance received, unless there is reliable evidence that arm’s length parties would have done so given the specific facts and circumstances.
CRA has confirmed that its position has not changed because of the COVID-19 pandemic at a roundtable held on September 15 by the Canadian branch of International Fiscal Association.
In fact, a representant of the Competent Authority Services Division mentioned that CRA expected the temporary assistance provided to Canadian taxpayers to remain in Canada, and not be used to reduce the transfer prices charged to foreign entities. He also did not provide examples of the market evidences that CRA expected from a taxpayer that decides to offset its costs against the assistance received in determining its transfer prices.
In light of this, it seems that it will be very difficult for a Canadian employer that receives the CEWS or other COVID-19-related government assistance to justify a reduction of the transfer prices charged to a related non-resident.
Reliable Evidence?
One of the biggest complain about TPM-17 is that the term “reliable evidence” is not defined in the document, and that there is no clear indication on how to demonstrate that cost-base used in the calculation of the transfer prices should be reduced by the amount of the assistance received because arm’s length parties would have done so. This critic is often heard from multinational group that have invested in R&D service center in Canada to benefit from the tax incentives provided by all levels of governments.
Although not specifically mentioned in TPM-17, it is reasonable to think that a reliable evidence would be a situation where a taxpayer that provides services to both related and arm’s length parties is able to demonstrate that its profitability on services provided to related parties is in line with the profitability on services provided to arm’s length parties.
Reliable evidence is even harder to demonstrate when a Canadian taxpayer acts as a service provider for the exclusive benefit of related entities. In that situation, one way to demonstrate that the profit earned by the service provider is arm’s length could be to calculate the markup on total costs (not reduced by the amount of government assistance received), and see if this lower markup on costs is still within an arm’s length range of markup on costs earned by comparable service providers.