TEI - Competent Authority Process in Canada And Related

Matters April 13, 2011

2

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)

3

What is Transfer Pricing and Canada’s Regulatory Environment?

4

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.

5

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).

6

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.

7

Types of Manufacturers

AM

Purchasing,

Prod. scheduling

Assembling

Technology

Inventory Title, Credit

Product Dev.

FFMMLMCM AM

Purchasing,

Prod. scheduling

Assembling

Technology

Inventory Title, Credit

Product Dev.

FFMMLMCM

8

Types of Distributors

Sales

Title,Credit

Inventory

Marketing

Add Value

MVDMDDLDA

Sales

Title,Credit

Inventory

Marketing

Add Value

MVDMDDLDA

9

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

10

• 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.

Canada’s Regulatory Environment (cont’d)

11

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.”

Canada’s Regulatory Environment (cont’d)

12

Dispute Resolution Avenues

• Appeals

• Competent AuthorityMutual Agreement ProcedureAdvance Pricing AgreementsArbitration

• Tax Court

• Avenue selected will depend on case specific factors

13

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.

14

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

15

Canadian Competent Authority

Organization Chart

Competent Authority Services Division (CASD)

Competent AuthorityServices Unit #1

Manager, Remi Gray

Competent AuthorityServices Unit #2

Manager - Dan Quinn

Competent AuthorityServices Unit #3

Manager, Brian Busby

Competent AuthorityServices Unit #4

Manager, Francis Ruggiero

Legal ServicesAdvisors

Competent AuthorityServices Economic Group

A/Chief Economist –Govindaray Nayak

Treaty Specialist- Tam NguyenCompetent Authority

Simultaneous AuditManager, Manon Helie

Exchange of Information and

Director, Patricia SpiceCompetent Authority Services Division

Competent AuthorityTechnical Cases GroupManager, Nadia Hassan

16

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.

17

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.

18

• 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

Factors in Reaching a Negotiated Settlement

19

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 limitii) 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.

20

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.

21

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.

22

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.

23

Updates on Arbitration and Mediation between Canada and the U.S.

24

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”.

25

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.

26

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

27

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.

28

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

29

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

30

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

31

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!

32

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

33

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

34

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)

35

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

36

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

37

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 payeri) Refund of taxes, arrears interest & penaltiesii) Refund Interest payable iii) 100% rectification

• Much confusion and inconsistency regarding the actual processing of the Part XIII refund upon repatriation

38

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.

39

• 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

Current CRA Audit Trends

40

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.

41

Questions?

montréal ottawa toronto hamilton waterloo region calgary vancouver moscow london

Thank You

www.taxand.com

Presenters:Dale HillPartner, Tax Services Tel: 613-786-0102E-mail: dale.hill@gowlings.com

Jim WilsonPartner, International Tax Services Tel: 613-786-0196E-mail: jim.wilson@gowlings.com