TEI - Competent Authority
Process in Canada And Related
Matters
April 13, 2011
Outline
• What is transfer pricing and Canada’s Regulatory
Environment?
• Deciding between appeals versus competent
authority
• Overview of the Competent Authority Process in
Canada
• Treaty Time Limits
• Update on arbitration under the 5th Protocol
• Secondary adjustments: current Issues
• Audit Settlements
• Current CRA Audit Trends (raising both PE and
Transfer Pricing Adjustments - Triple Tax)
2
What is Transfer Pricing and Canada’s
Regulatory Environment?
3
Transfer Pricing Defined
Transfer Pricing is:
The price at which goods, services and
intangibles are traded between non-arm’s length
parties within a corporate group.
4
When Transfer Pricing Issues Arise
Transfer Pricing Issues Arise:
Whenever
goods,
services
(e.g.
marketing,
accounting) or intangibles (e.g. patent or trade mark
rights) are transferred between related parties across
international borders (and in some cases provincial).
5
Importance of Transfer Pricing
• Since a change in transfer prices can result in a
change in profits reported in a particular tax
jurisdiction, tax authorities around the world have
made transfer pricing a priority.
• Recent comments out of the U.S. suggest that
transfer pricing may be more closely scrutinized in
the future.
• While not addressing transfer pricing specifically,
comments from the U.S. suggest that several tax
loopholes may be restricted or shut down.
6
Types of Manufacturers
CM
LM
M
AM
FFM
Product Dev.
Purchasing,
Prod. scheduling
Inventory
Title,
Credit
Technology
Assembling
7
Types of Distributors
A
LD
D
MD MVD
Add Value
Marketing
Inventory
Title,Credit
Sales
8
Canada’s Regulatory Environment
• Section 247 of the Income Tax Act (ITA)
• Information Circular (IC) 87-2R – International
Transfer Pricing
• IC 71-17R5 – Guidance on Competent Authority (CA)
Assistance Under Canada’s Tax Conventions
• IC 94-4R – Advance Pricing Arrangements (APAs)
• IC 94-4R (Special Release) – APAs for Small
Businesses
9
Canada’s Regulatory Environment (cont’d)
• For transfer pricing issues, the main body of the
legislation is found in Section 247 of the Income Tax
Act (the “Act”) and the CRA’s guidelines as set forth
in the Information Circular (“IC”) 87-2R.
• For the purpose of customs valuation, the applicable
sections of the Customs Act are sections 44-57.
• The CBSA’s D-series memoranda also provide
additional information with respect to the application
of the valuation rules.
10
Canada’s Regulatory Environment (cont’d)
IC87-2R addresses the issue of differences with the
customs act:
“The methods for determining value for duty under the
current provisions of the Customs Act resemble those
outlined in this circular. However, differences do
remain. The Department is not obliged to accept the
value reported for duty when considering the income
tax implications of a non-arm’s length importation.”
11
Dispute Resolution Avenues
• Appeals
• Competent Authority
Mutual Agreement Procedure
Advance Pricing Agreements
Arbitration
• Tax Court
• Avenue selected will depend on case specific factors
12
Appeals vs. Competent Authority
• Treaties do not impact taxpayer’s domestic appeal
rights.
• MAP Article is simply an additional option for dispute
resolution.
• Appeals and competent authority will not work files
simultaneously.
• In transfer pricing cases, Appeals do not resolve
economic double tax unless the entire adjustment is
overturned.
13
Appeals vs. Competent Authority
• Reasons to go to Appeals before Competent
Authority:
• if no double tax exposure due to losses that will not
be utilized
• Small amounts
• Quicker resolution since no government to
government negotiations
• No “red flags” to foreign government of other issues
14
Canadian Competent Authority
Organization Chart
Competent Authority Services Division (CASD)
Competent Authority Services Division
Director, Patricia Spice
Competent Authority
Services Unit #1
Manager, Remi Gray
Competent Authority
Treaty Specialist- Tam Nguyen
Competent Authority
Services Unit #2
Manager - Dan Quinn
Exchange of Information and
Simultaneous Audit
Manager, Manon Helie
Competent Authority
Services Unit #3
Manager, Brian Busby
Competent Authority
Services Unit #4
Manager, Francis Ruggiero
Legal Services
Advisors
Competent Authority
Services Economic Group
A/Chief Economist –Govindaray Nayak
Competent Authority
Technical Cases Group
Manager, Nadia Hassan
15
Competent Authority Process
• Notification to the Competent Authority
• Notification is the taxpayer’s responsibility
• Must have a tax treaty with the foreign country.
• Using economists, CA will prepare a position paper
and send to the foreign government.
16
Competent Authority Process (cont’d)
• If agreed to by the foreign CA - adjustment
processed.
• Where there is disagreement, the case is negotiated.
• Taxpayers can accept or reject the settlement and go
to Appeals if they have filed a Notice of Objection.
17
Factors in Reaching a Negotiated Settlement
• Quality of documentation
• Availability of economic data
• Transfer pricing is not an exact science
• Materiality of adjustments
• Similar facts and circumstances in other cases
• Policy decisions
18
Treaty Time Limitations
Time Limits for CRA to raise TP adjustments
• 5 to 7 years limits in many of Canada’s treaties.
i) CRA cannot raise transfer pricing beyond specified
time limit
ii) Some controversial situations arise when CRA
ignores time limit (e.g. foreign entity in loss position)
• Canada- U.S. Treaty does not prevent CRA from
reassessing beyond 6 year notification period.
• As double tax may arise in both scenarios above,
recourse is available under Article IX(4) and/or MAP.
19
Assessments Beyond the 6 Year Notification
• If notification is not given to the IRS within 6 years
from the end of the year in which the adjustment
relates, the IRS will not have to provide relief from
double taxation.
• In the majority of cases, double taxation would be
the result.
• Under section 152(4)(b) of the ITA the CRA has 7
years to reassess international transactions. A
reassessment can be issued in the seventh year after
the expiration of the 6 year notification period
provided by the Canada-US treaty.
20
Assessments (cont’d)
• In effect, Paragraph 4 of Article IX states that if the
taxpayer is not notified of a proposal by the CRA
within the six year period, CRA may provide relief
and not proceed with the adjustment if it would result
in double taxation.
• CRA can technically proceed in adjustments without
further consideration and has previously done so
BUT this is not a certainty.
21
Assessments (cont’d)
• Taxpayers should be alert and request in writing that
a proposal be issued, prior to the expiration of the
treaty notification period in order to protect itself of
the right to relief from double taxation.
• Whether or not the CRA issues its proposal on time,
the taxpayer should submit a notification to foreign
competent authority to ensure its rights are
protected.
22
Updates on Arbitration and Mediation between
Canada and the U.S.
23
Mandatory Arbitration : OECD Model
• The fifth protocol amends the Mutual Agreement
Procedure Article XXVI of the Canada-U.S. treaty, and
puts in place a mechanism referred to as “mandatory
arbitration”.
24
Mandatory Arbitration (cont’d)
• Mandatory arbitration introduced by the Protocol is
not entirely taxpayer friendly.
• The arbitration board decides between two
proposals.
• Once a decision by the arbitration team is rendered,
and if that decision is accepted by the taxpayer, the
decision is binding.
• The taxpayer can choose to reject the final
determination of the arbitration committee and seek
resolution through the judicial process.
25
Mandatory Arbitration (cont’d)
• Before one engages mandatory arbitration, three
criteria must be met:
tax returns must have been filed in at least one of the
two States for the taxation years involved
the case must not be considered a case that the
competent authorities both agree is not suitable for
arbitration
the taxpayer must agree in writing to keep all the
information exchanged in the arbitration process
confidential
26
Mandatory Arbitration (cont’d)
• The decision of the arbitration team is binding.
• The arbitration board is not subject to revision and
does not need to provide an explanation for its
decision.
• Mandatory arbitration may provide competent
authorities with more incentive to arrive at a
negotiated settlement.
27
Mandatory Arbitration (cont’d)
• The decision to proceed with arbitration lies in the
hands of the taxpayer.
• Taxpayer may withdraw from competent authority
consideration even if arbitration has already begun
• The arbitration decision must be provided in writing
no later than six months following the date of the
committee’s appointment.
From a taxpayer’s perspective, this is very
encouraging
28
Mandatory Arbitration – What’s New?
• Recent Developments
• On 25 November 2010, the CRA and IRS released
detailed guidance in the form of a memorandum of
understanding (MOU) on how the arbitration process
will operate
• December 15, 2010 official start of arbitration
eligibility for many MAP files that were in inventory
on December 15, 2008
29
Mandatory Arbitration – What’s New?
• November 25th MOU between CRA & IRS
• Provides further information regarding the process
and conditions to enter into arbitration proceedings
• Clarifies the process for those cases that were in
inventory at December 15, 2008
• Confirms that Advanced Pricing Arrangements
(APAs) are eligible for arbitration
• Describes two step process for PE cases
30
Mandatory Arbitration – What’s New?
• Early Indications are all Positive!
• Indications are that many older MAP files have been
closed (settled) and arbitration avoided
• This was the treaty negotiator’s intention behind
Mandatory Arbitration!
31
Secondary Adjustments
Background
• Upon transfer pricing (“TP”) adjustments, tax
records are adjusted to reflect ALP
• Allocation of income among related parties rectified
for tax purposes only (assets still outside Canada)
• Several complex scenarios
32
Secondary Adjustments (cont’d)
Background
• Canadian regime is to consider a shareholder benefit
to be conferred on NR parent
• Result: Deemed dividend and Part XIII tax payable +
failure-to-withhold assessment against Canadian
payer
• Secondary adjustment raised by audit immediately if
no repatriation agreement
• Potential for double tax
• OECD silent on issue – left to each country
33
Secondary Adjustments (cont’d)
Current Issues
1. Part XIII tax already withheld on TP transaction
2. Repatriation policy (Tax Service Office policy versus
Competent Authority policy)
3. Processing refund of Part XIII tax after MAP
settlement (assuming repatriation)
34
Secondary Adjustments (cont’d)
Part XIII tax already withheld on TP transaction
• For example, trademark royalties (10% Treaty Rate)
• Secondary Adjustment – Deemed Dividend results in
additional 5% Part XIII Tax
• May not refund initial Part XIII withholding tax (e.g.
statute barred – subsection 227(6))
• CRA should not be double taxing same flow of funds,
even if it is temporary!
• Taxpayers may have immediate recourse under MAP
Article without having to wait for MAP settlement on
primary adjustment
35
Secondary Adjustments (cont’d)
Repatriation Policy
(Tax Service Office vs. Competent Authority)
• No significant advantages to accept TSO repatriation
policy
• TSO repatriation policy may still have some Part XIII
tax implications (imputed interest)
• Competent Authority repatriation policy has no
adverse tax implications
36
Secondary Adjustments (cont’d)
Processing Refund of Part XIII Tax after MAP
Settlement (assuming repatriation)
•
•
NR7 Refunds (subsection 227(6) process) –
generally no refund interest
Cancelling a Part XIII Failure-to-withhold
assessment to Canadian payer
i) Refund of taxes, arrears interest & penalties
ii) Refund Interest payable
iii) 100% rectification
•
Much confusion and inconsistency regarding the
actual processing of the Part XIII refund upon
repatriation
37
Audit Settlements in Transfer Pricing Cases
• Where audit settlement is reached, taxpayer may be
asked to waive appeal rights.
• However taxpayer can still go to competent authority
(i.e. no legislative authority to waive treaty rights).
• If appeal rights are waived, there is no collection
deferral (be careful!).
• Competent authorities must ignore audit settlements
and negotiate on transfer pricing principles on the
actual adjustment that was made.
38
Current CRA Audit Trends
• Assessing the same economic income to the
Canadian subsidiary under a transfer pricing audit as
well as the nonresident parent company under a
Permanent Establishment audit.
• Triple tax
• Objective is not to double tax but to “ensure income
gets taxed once”
• Appears to be a strategy to allow Appeals or
Competent Authority the opportunity to choose what
is the strongest case
39
Conclusion
• Intercompany charges for goods, services and/or
intangibles must be well documented.
• Taxpayers must ensure their transfer pricing
documentation can hold up to the scrutiny of tax
authorities.
• Many avenues exist to assist corporations in
relieving themselves of potential double tax.
• Legislation is rapidly changing with an opportunity
for corporations to benefit from new rules.
40
Questions?
41
Thank You
Presenters:
Dale Hill
Partner, Tax Services
Tel: 613-786-0102
E-mail:
dale.hill@gowlings.com
Jim Wilson
Partner, International Tax
Services
Tel: 613-786-0196
E-mail:
jim.wilson@gowlings.com
www.taxand.com
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