Life is getting harder for Canadian multinationals trying to reduce taxes by transferring profits abroad.
In its latest budget, the federal government committed to increasing enforcement efforts against companies that improperly shift profits to lower-tax countries by abusing a legal practice known as transfer pricing — but the Canada Revenue Agency has already been cracking down on the abuse for years.
Data released by the CRA under access-to-information legislation shows that the average penalty for improper transfer pricing increased from $3.4 million 2012 to $15.9 million in 2015.
Total penalties, meanwhile, climbed from $58.6 million in 2012 to $478.5 million last year, as both the number of files under review and the size of the disputed transactions have increased.
"The numbers are big and meaningful, and they keep going up," said David Hogan, a cross-border tax specialist at financial consultancy Richter, who obtained the statistics.
"This is not going away; this is the start of something."
Companies are allowed to establish contracts and charge fees with subsidiaries in other countries as part of transfer pricing, but in some cases, companies improperly inflate those costs in lower-tax countries to shift profits there.
The challenge is determining what is an appropriate cost for everything from a Tim Hortons trademark licence to the value of a uranium export contract or how research costs are shared between divisions.
"Transfer pricing is in many ways more of an art than a science, because you don't have a precise number, you have a range," said Christopher Steeves, leader of Fasken Martineau's tax practice group.
He said he's seen in his own practice that multinational companies in Canada are being audited more regularly and being challenged on their transfer pricing, and expects a lot more audits and reassessments are coming.
"It's definitely a growing issue," said Steeves. "Transfer pricing is really in the hot light so to speak, and governments including Canada's are looking at whether or not there are taxes that are slipping through the cracks."
The standard of what's appropriate changed in 1997, when the OECD decided that companies have to set the contracts at an arms-length threshold, said Hogan. That means the contracts have to be similar to what two unrelated companies would agree to.
Since then, many Canadian companies have been ensnared with the taxman. They range widely from Spin Master Corp., owner of Etch A Sketch and other toys, who agreed to a $15-million settlement last December, to uranium miner Cameco, who was in the Tax Court of Canada this week contesting what it expects could be a $2.2-billion tax bill.
CRA spokeswoman Lisa Damien said the agency continues to update its risk assessment tools and to increase communication with other tax authorities as it boosts enforcement.
"The CRA is committed to combating the abusive use of offshore jurisdictions and protecting the integrity of the Canadian tax system," said Damien in an email.
The federal government set aside about $444 million over five years to increase resources in its latest budget, and also committed to putting in place stricter reporting requirements for large companies.
And in April, the federal government specifically committed to hire 100 additional auditors to investigate high-risk multinational corporations, a strategy that it says will collect an additional $500 million in revenue over five years.
Based on preliminary numbers for the fiscal 2015-2016 year, the CRA has identified over $7 billion in additional fiscal impact though its international, large business, aggressive tax planning and offshore compliance programs, said Damien. That amount is close to a billion dollars more than in the 2013-2014 year, she added.
Hogan said companies are starting to adapt to the new regulatory environment, but with so much grey area, and so little case law on transfer pricing, there is much that remains unclear.
Companies are also perfectly allowed to pay as little as required, said Hogan, so they will continue to look for the best options to reduce their tax bill.
"This is an ongoing arms race between tax authorities and tax payers," he said.
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