6 December 2011 Roundtable, 2011-0427301C6 - 2011 TEI-CRA Liaison Meeting: Qu.11

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Principal Issues: Transfer Pricing
a) Would CRA be willing to apply the approach (or results) achieved in a negotiated Competent Authority agreement between treaty countries to all identical transactions, even for transactions with non-treaty countries?
b) Would CRA develop audit guidelines to ensure the efficient use of limited taxpayer resources and curb the issuance of overboard Information Requests? Will CRA consider staffing the Competent Authority proceeding with an economist who is independent from the audit team?
c) Would CRA consider deferring its reassessment of the Part XIII amounts until the underlying transfer pricing issue has been resolved? Alternatively, would CRA consider applying collection rules similar to subsection 225.1(7) to Part XIII tax so that the amount of Part XIII payable by a taxpayer during the pendency of an Appeal or Competent Authority proceedings is limited to 50% of the tax amount?

Position: See response.

TEI-CRA Liaison Meeting
December 6, 2011

Question 11 - Transfer Pricing (2)

a) Application of Arm's Length Transfer Prices Established through Competent Authority or an APA to Similar Transactions with Non-Treaty Countries

Taxpayers often have transactions with multiple, related, non-resident companies where the nature of the transactions and the applicable transfer-pricing methodology are identical. Would CRA be willing to apply the approach (or results) achieved in a negotiated Competent Authority agreement between treaty countries to all identical transactions, even for transactions with non-treaty countries? Using the same approach for identical transactions would be more efficient for taxpayers and government and ensure consistent treatment of transactions.

CRA Response

Competent Authority settlements under the Mutual Agreement Procedure (MAP), including bilateral or multilateral advance pricing arrangements, are not precedent setting. That is, they are settlements entered into for the purpose of relieving double taxation or taxation that is not in accordance with a treaty in respect of (a) particular taxpayer(s), particular taxation year(s) and particular transaction(s). Furthermore, terms of individual treaties vary and may not all apply equally; therefore, similar transactions between residents of different treaty-partner countries may end up with a different resolution under the MAP process.

b) International Tax Directorate Economists

In international audits of large corporations in Canada, a team from CRA's International Tax Directorate (ITD) is often assigned to the file in support of the local auditor's review. Two trends have developed, however, that are disconcerting to taxpayers.

First, when taxpayers inquire why they have received inapt or overbroad requests for information, the local auditor's response often is that the ITD is directing the audit from Ottawa.

Second, when a transfer pricing adjustment is raised and the taxpayer applies to Competent Authority for relief, the economist from ITD who wrote the report in support of the adjustment is often brought into the Competent Authority proceeding to assist in resolving the MAP case. Similarly, the economist that assisted in a field audit may also be an advisor to Competent Authority in respect of an APA case.

i) In respect of the first trend, would CRA develop audit guidelines to ensure the efficient use of limited taxpayer resources and curb the issuance of overbroad Information Requests that, for example, require production of "all documents ever produced"? In many cases, a taxpayer could never reasonably comply with such a request whether voluntarily or under a court order.

ii) With respect to the second trend, taxpayers believe that having the same ITD economist participate in both the field audit and the MAP (or APA) case is a conflict of interest comparable to assigning the field auditor who reassessed a taxpayer to the appeal of issues identified in a taxpayer's Notice of Objections. Will CRA consider staffing the Competent Authority proceeding with an economist who is independent from the audit team?

CRA Response

i) When auditors come up against complex issues and require assistance, they can avail themselves of the ITD's International Advisory Services. These Headquarters-based teams are available to provide advice and assistance on the proper conduct of an audit of international tax issues. However the ITD has different methods to ensure that the right questions are being asked of the right parties and that verification of taxpayers' positions can be done as quickly and efficiently as possible, while ensuring a thorough review is done. An example of this is the policy on mandatory referrals to the ITD of files with certain characteristics, which has been in place for about one year now. This policy requires that files involving intangibles, involving proposed reassessments on years that are or will be time barred by treaty, or involving cost contribution arrangements are to be referred to Headquarters.

The ITD has also established a program with the Department of Justice to ensure timely access to lawyers during the conduct of the audit so that taxpayers are not faced with requirements or other legal processes that may be improperly drafted and therefore wasteful for all parties. The ITD's advice to auditors in transfer pricing files typically is that the proper documentation must be collected in order to properly verify the tax position taken. When auditors examine the books and records and want to verify an entry, they do not just look at the entry. They look at the manner in which the entry was derived and all of the data that resulted in it. It is the same for a transfer pricing audit. Information on the transactions, the parties thereto, the functions performed, taking account the assets used and the risks assumed by each of the parties, the business context of the transaction, and how it is expected to generate value are among the information that is required to verify a transfer price. The ITD's advice is to gather and analyze this information as efficiently as possible.

ii) The Competent Authority Services Division (CASD) has always staffed its APA program with its own economists. However, recently, in order to meet the demand of growing APA inventory, the CASD has borrowed some economists from the International Tax Division (ITD). In addition, it has started using the services of ITD senior economists on APA cases based on their availability. Given limited economist staff available to the CRA, it is efficient for CASD to use ITD economists on APA cases and we would point out that the coincidence of an economist working on both an audit and APA for the same taxpayer is extremely rare. When it does occur, the ITD economist has had an opportunity to learn a great deal about taxpayer's transactions and is available to assist CASD to arrive at a reasonable position for negotiation.

It is important to note that the economist's job is to provide an unbiased transfer pricing analysis of a transaction solely based on the facts and circumstances applying the arm's length principle, whether the analysis is related to audit or APA. It is also important to note that APA positions are developed under the guidance of CASD's Chief Economist and hence the positions are developed to accord with CASD's mandate to resolve double taxation. Given CASD's mandate under the treaty and the rarity of the same economist working on the file at both the audit and APA stages, the potential for conflict of interest in using the ITD economists' services on APA cases should be either a non-existent or acceptable risk when balanced against the effective use of CRA's economic resources.

CASD does not use ITD economists' services on MAP cases. If an ITD economist has completed an analysis for an international transfer pricing audit that presents as a MAP case, CASD may ask for details of the economic analysis from the ITD economist. The purpose of the discussion is to understand the basis and rationale of the analysis which assists CASD to arrive at a position for the case. The CASD analyst is solely responsible for preparing the MAP position paper. Any additional economic analysis, if required, is done by a CASD economist.

c) Non-resident Withholding Tax related to Transfer Pricing Adjustments

After CRA issues a transfer pricing reassessment under section 247 a secondary adjustment is typically made pursuant to paragraph 214(3)(a) for an amount considered to be a benefit - a deemed dividend - paid by a corporation resident in Canada to its "ultimate shareholder." Subsection 212(2) of Part XIII is then applied to tax the deemed dividend at a rate of 25 percent, subject to reduction under an applicable treaty with the non-resident's country. Once CRA reassesses the Part XIII tax amount, there is seemingly no provision under the Act permitting a taxpayer to defer payment or to pay any amount less than the full amount of tax plus interest.

Where a taxpayer is successful in obtaining a reduction in the transfer pricing adjustment (whether at Appeals or Competent Authority), a corresponding reduction in the proposed Part XIII tax will result.

i) Would CRA consider deferring its reassessment of the Part XIII amounts until the underlying transfer pricing issue is resolved? Such a delay would permit the final amount of Part XIII tax liability to be determined before the taxpayer is required to pay that tax.

ii) Alternatively, would CRA consider applying collection rules similar to subsection 225.1(7) to Part XIII tax so that the amount of Part XIII payable by a taxpayer during the pendency of an Appeal or Competent Authority proceedings is limited to 50 percent of the tax amount?

CRA Response

i) The CRA has considered deferring the assessment of Part XIII tax resulting from a transfer pricing adjustment and concluded that such an approach is not advisable.

The performing of a review, raising of an assessment or directing that one be done falls within Audit's mandate while the mandate of Appeals and Competent Authority is to provide relief, if warranted, from actions taken by Audit. Thus, it is Audit's duty to raise all applicable assessments based on the facts before it, in accordance with the Income Tax Act. These assessments crystallize the taxpayer's obligation to make payment (or provide appropriate security), raise the issues, and define the issues for consideration by Appeals or Competent Authority.

Upon receiving a (re)assessment on a transfer pricing issue, a taxpayer has a number of options: do nothing, make a competent authority request, and/or file an objection and possibly an appeal to the courts. Audit has no way of knowing at the conclusion of an audit which course of action will be pursued, or where or how the case will eventually be resolved. Moreover, if a taxpayer decides to proceed with an objection or an appeal, by the time the associated transfer pricing issue is resolved, the CRA could be barred from raising a Part XIII assessment not by the Income Tax Act but by the time limitations in the applicable tax treaty. Canada has over 80 tax treaties with varying rules regarding time limits. For example, the MAP Article in the Canada-Switzerland tax treaty states that "[a] Contracting State shall not,... after six years from the end of the taxable period in which the income concerned has accrued, increase the tax base of a resident of either of the Contracting States by including therein items of income which have also been charged to tax in the other Contracting State." It would be difficult to develop and administer transfer pricing agreements for the assessment of Part XIII tax that takes into consideration the varying rules in Canada's treaties. In this respect, we are concerned that the administration of transfer pricing could become cumbersome and inefficient and could lead to the loss of Part XIII tax revenues.

ii) With regard to Part XIII (Non-Resident Withholding Tax) amounts, which typically represents a secondary adjustment and assessment related to a transfer pricing reassessment, the withholding provisions do not contain any collection restrictions and are payable forthwith.

However, Part XIII collection policy has also been adopted and applied by CRA in recognition of the OECD guidelines on Transfer Pricing by allowing MNE's to post acceptable security in lieu of the 100% payment as required by the Income Tax Act.

The Part XIII security policy position has been adopted to mitigate the risk of default but also to provide financial flexibility to MNE's when repatriation terms under a MAP settlement are being considered. In practice, once the repatriation of MNE's income has been satisfied under a MAP agreement, the Part XIII assessment is typically reversed, and the security provided is released.

Recognizing that CRA's large corporation Part I and Part XIII collection policy is consistent with related OECD guidelines and prudent fiscal policy, the recommendation to introduce any legislative rules that would alter this policy position is not supported by CRA.

However, to address recommendation (6) by the Transfer Pricing Subcommittee and to clarify Part I and Part XIII collection policy and practices concerning transfer pricing MAP proceedings, Information Circular 71-17R5 will be amended when revisions are being considered to reflect the collection policy that security in lieu of 100% payment is acceptable.

With respect to the suggestion that the Part XIII payment obligation be reduced to 50% instead of 100% during MAP proceedings, we would simply note that the CRA has no legislative basis for reducing the payment obligation and, for the reasons discussed above, we are not supportive of this approach.