Transfer pricing considerations if your business has applied or is applying for Government subsidies such as Canada Emergency Wage Subsidy (“CEWS”) in the context of COVID-19.

• As of September 30, 2020, over 1 million Canadian employers have applied for the Canada Emergency Wage Subsidy (“CEWS”), where corporations were adversely affected by COVID-19 pandemic, therefore significantly reducing their revenues since March 2020. The Government provided specific eligibility criteria for corporations to apply for the CEWS, including those where a large portion of the revenues are derived from sales to a related, non-resident, who might then sells to third parties.

• Specific transfer pricing implications arise in the context of Government subsidies such as CEWS. For example, one way that taxpayers could manage the pandemic’s adverse impact on their businesses is by including or sharing all or part of the COVID-19 government assistance with a related non-resident. This could take the form of reducing allocable costs for mark-up. However, the Canada Revenue Agency (“CRA”) has not specifically addressed this in the Transfer Pricing Memorandum-17 (TPM-17 was published in March 2016)

• According to TPM-17, when a taxpayer receives governmental subsidies and uses a cost-based transfer pricing methodology to determine the transfer price of goods, services, or intangibles sold to a related non-resident, the cost base should not be reduced by the amount of the government assistance received. The only exception to this guidance is that there should be reliable evidence that arm’s length parties (independent third parties) would have contracted similarly given the specific facts and circumstances. The 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 the International Fiscal Association (IFA).

• The CRA expects the temporary assistance provided to Canadian taxpayers to remain in Canada, and should not be used to reduce the transfer prices charged to foreign entities. There are no specific examples provided in the context of market-based comparable data that CRA will expect or accept from a taxpayer that decides to offset its costs against the assistance received in determining its transfer prices. As a result, it seems that it will be challenging for a Canadian taxpayer that receives the CEWS or other COVID-19-related government assistance to substantiate a reduction in the inter-company price(s) charged to a related non-resident.

• As a practical next step, affected taxpayers should undertake an arm’s length analysis to demonstrate that the prices charged reflect arm’s length prices and are not merely an application of a cost-plus formula. This will take the form of an up-to-date arm’s length analysis prepared by the taxpayer to determine if a reduction to the inter-company price reflects market rates and the cost base is not reduced by the Government subsidy received. Furthermore, the outcome of such analysis and resulting positions adopted must be documented accordingly. The absence of supporting information will likely result in penalties and potentially increase the taxpayer’s income tax obligations in Canada. Considering TPM-17 does not provide clarity on reliable evidence, and there is no precedent on demonstrating that the cost-base used for transfer pricing purposes should be reduced by the amount of Government assistance received, having supporting documentation to prove that arm’s length (independent) parties would transact similarly, becomes critical.

For further information or any assistance you require on your cross-border inter-company arrangements, contact our Transfer Pricing Principal & Practice Leader Avinash S. Tukrel.