CRA Steps Up International Tax Audits

From KPMG report:

A recent report of the Auditor General (AG) indicates that the CRA has become increasingly concerned with the tax risks associated with international transactions. Although the AG found that the CRA is better able to identify potential non-compliance with the tax rules on international transactions, the CRA still needs to improve in several areas.

Given the CRA’s increased focus on international tax issues, including transfer pricing, Canadian corporations that undertake transactions with related parties in foreign jurisdictions face an ever-increasing probability of a transfer pricing audit by the CRA.

Consequently, corporations should be diligent in developing and implementing transfer pricing policies, as well as preparing appropriate transfer pricing documentation in an effort to reduce the likelihood of a transfer pricing adjustment in the event of a CRA audit.

CRA’s focus on international taxation issues

Aggressive tax planning, which includes international tax compliance, has been one of the CRA’s top four compliance priorities since 2004. As noted in the 2007 AG report, the CRA estimates that over 16,000 Canadian corporate taxpayers report some type of foreign transaction with related parties. These related-party transactions are estimated to involve more than $1.5 trillion in 2005.

The 2005 federal budget allocated $30 million annually to the CRA to address aggressive international tax planning. The CRA is using these funds to research tax avoidance and to increase the number of international auditors and tax avoidance auditors. As of March 31, 2006, the CRA had 320 international auditors and researchers and 210 non-resident auditors and program officers.

Auditors now use checklists and other planning tools to help them determine whether a corporation may be non-compliant and to begin transfer pricing and foreign affiliate audits. In addition, the time budgeted for an international audit of a large corporation has increased significantly. In 2006, the CRA’s total international audit reassessments had increased to $941 million from $778 million in 2001. The additional tax assessed on international transactions by large corporations was $729 million, compared to $300 million in 2001.

International auditor expertise and support

In its 2002 report, the AG expressed concern about the lack of adequately trained and experienced international auditors who were available to undertake transfer pricing and foreign affiliate audits.

A lack of adequate international audit experience was still observed by the AG in 2006. For example, in two Greater Toronto Area (GTA) tax services offices (TSOs), more than 40 percent of auditors had less than two years of international audit experience, while four of the ten international audit team leaders had less than one year of international team leader experience.
In an attempt to combat the lack of international audit experience, the CRA added 140 international and avoidance auditors and 39 experienced auditors to perform research studies. In addition, since 2002, the agency increased the total number of economists it employs to 16. However, the 2007 AG report notes that some TSOs continue to lack adequate training and experience in international audits, especially in the GTA.

The 2007 AG report noted that only 25% of audit recoveries came from the GTA, where more than 40% of large corporations report non-arm’s length transactions. It is suspected that tax recoveries in the GTA have been lost due to inconsistencies in the approach and coverage of international audits. The 2007 AG report also noted that, even though economists have been involved from the onset of the audit, they have limited experience in transfer pricing audits and lack industry-specific expertise.

Foreign documentation requests

The 2007 AG report revealed that the CRA has increased the use of information requests from foreign jurisdictions. However, the report concluded that auditors are still not making sufficient use of these provisions where taxpayers failed to provide the information voluntarily.