CRA revises return for reporting transactions with non-arm’s length nonresidents
The Canada Revenue Agency (CRA) has amended the return for reporting transactions with non-arm’s length nonresidents, with effect for tax years commencing on or after 1 January 2022. For over 30 years, the CRA has required reporting of transactions and account balances with non-arm’s length nonresidents, and the form, the T106 Information Return of Non-arm’s Length Transactions with Non-residents, or T106 Return, which consists of a Summary Form and a separate Slip for each nonresident, has been updated periodically. The T106 Return must be filed when total transactions during a taxation year between a reporting person, which may be a corporation (including the Canadian branch of a nonresident that must report transactions with other non-arm’s length nonresidents), individual or trust, or a partnership, and all non-arm’s length nonresidents exceed CAD 1 million. This threshold is considered relatively low and has not changed since the T106 Return was introduced. An authorised officer, person or representative must sign the certification declaration section of the T106 Return, attesting that the information provided is correct and complete.
The T106 Return requires that certain information be provided about the reporting person or partnership, and about each nonresident, including the relationship to the reporting person or partnership. In addition to reporting the transaction volume of intercompany transactions, the transfer pricing methodology used and certain intercompany balances, the reporting person or partnership must respond to the question as to whether or not contemporaneous transfer pricing documentation has been prepared or obtained. For many years, the CRA has used the response to this question as a screening tool for audit purposes. Although the CRA may levy a transfer pricing penalty on audit, there is no penalty for not preparing transfer pricing documentation, so if such documentation does not exist, the response should be “no.”
The CRA is serious about compliance when it comes to reporting of transactions with non-arm’s length nonresidents so it is critical that the T106 Return be accurately prepared. There are potential late filing penalties of up to CAD 2,500 per late-filed T106 Slip. Where the reporting person or partnership knowingly or through negligence fails to file the T106 Return, a non-filing penalty of up to CAD 12,000 per return may be assessed, and may be doubled if the failure persists after a formal demand by the CRA. There are also potential penalties of CAD 24,000 where the T106 Summary or Slip is incomplete or incorrect due to a false statement or omission. Finally, there are potential third-party civil penalties that may be levied against a professional advisor equal to the sum of the professional fees charged, plus CAD 100,000, where the information reported contains a false statement or omission and the professional advisor was directly or indirectly involved, knowingly or through negligence, with making the false statement.
Changes of particular relevance
The most important changes made to the T106 Return are as follows:
- Part II of the T106 Slip now asks for the nonresident’s taxpayer identification number, which presumably will assist the CRA in requesting information from the foreign taxation jurisdiction under the relevant tax treaty.
- A new question is added to Part IV as to whether a Pertinent Loan or Indebtedness (PLOI) Election was made, and if so, the amount of the deemed interest included in the reporting person’s taxable income pursuant to the election must be reported. Canada has sophisticated rules that apply in situations where a Canadian-resident corporation provides debt financing to its nonresident shareholders or any other nonresident person with whom the nonresident shareholders do not deal at arm’s length. Under certain circumstances, the debt financing provided to the nonresident will be treated as a deemed dividend paid to the nonresident, which is taxed as a normal dividend, subject to a 25% Canadian withholding tax unless the rate is reduced pursuant to the applicable tax treaty. The nonresident shareholder may apply for a refund of the withholding tax when the shareholder loan is repaid unless the repayment is part of a series of loans and repayments. If the shareholder loan is repaid within one year after the end of the taxation year of the Canadian-resident lender in which the loan was made and the repayment is not part of a series of loans and repayments, the loan will not be subject to the shareholder loan rules. Nevertheless, the nonresident entity will be deemed to have received a benefit from the Canadian-resident lender if the loan is non-interest-bearing or if the interest rate is less than the interest rate prescribed by the CRA. The benefit conferred is equal to interest calculated at the prescribed rate and is treated as a deemed dividend subject to Canadian withholding tax, which is not refundable. Under the PLOI rules, a shareholder loan may be exempted from these rules if the loan meets the following criteria:
- The loan is payable by a nonresident corporation (“subject corporation”) to a corporation resident in Canada (CRIC);
- The CRIC was controlled by the subject corporation when the loan was received by the subject corporation; and
- The CRIC and the subject corporation jointly file an election (PLOI election) to treat the loan as a PLOI.
Under the PLOI rules, if the loan carries an interest rate less than the rate prescribed by the CRA, the CRIC must include deemed interest income in its taxable income. This information is provided for context, and any further discussion of the PLOI regime is beyond the scope of this article, but suffice to say it is complex. The amount of the PLOI election must now be reported on the appliable T106 Slip. There is some controversy about this new requirement because the PLOI election is not a “transaction” between the reporting entity and the non-arm’s length nonresident.
- The new T106 Slip also requests additional information about the non-arm’s length nonresident’s investment in the reporting entity and specifies that the amount that must be reported is the reporting entity’s paid-up capital (PUC). Frequently, a Canadian corporation’s PUC is equal to its stated capital on its financial statements, but not always. Stated capital is the amount that was received by the Canadian corporation for the issuance of shares to the nonresident. PUC is intended to reflect the amount that may be returned by a Canadian corporation to its shareholders, including nonresident shareholders, free of Canadian tax. All other distributions are either dividends or taxable shareholder benefits. PUC is relevant in determining the tax consequences of corporate reorganisations, distributions and dissolutions and may not be equal to the corporation’s stated capital. PUC is equal to stated capital plus or minus certain adjustments, which are generally designed to prevent a corporation from using tax-deferred transactions to increase the stated capital, and hence the PUC, of a corporation. As with all information reported on the T106 Return, it is important that the amount reported as PUC be accurate.
In summary, it appears the CRA may be requesting additional information for screening and audit selection purposes. It is important that every effort be made to ensure T106s are completed accurately.