With the OECD’s Action Plan on Base Erosion and Profit Shifting (BEPS)  and Revised Discussion Draft on Transfer Pricing Aspects of Intangibles,  as well as CRA transfer pricing audit activity and recent Canadian tax court decisions, transfer pricing continues to be a hot topic, keeping owner-managers, CFOs, tax directors, and controllers awake at night.
This article picks up from where we left off in “Transfer Pricing Audits Present Unique Challenges” and “Transfer Pricing: Latest Status Report”—articles we wrote for Beyond Numbers magazine in 2011 and 2012, respectively. In these previous articles, we identified some of the unique challenges to which taxpayers are subject during transfer pricing audits, and the costs of transfer pricing reassessments. We also discussed Part I of the tax authority transfer pricing dispute process: the CRA audit and reassessment.
Part II—competent authority, the process of obtaining relief from double taxation—is the primary focus of this article.
Competent authority – Part II of the transfer pricing dispute process
When a taxpayer is reassessed with additional tax due to a transfer pricing adjustment, there is often double taxation, as two entities within the related group will have paid or be subject to tax on the same amount of income. For example, if the CRA denies a $1-million management fee charge made by a US taxpayer to its related Canadian taxpayer and issues a transfer pricing reassessment, the Canadian taxpayer must pay income tax on the $1-million adjustment, even though its related US entity has already paid US tax on this same amount.
For these situations, the best approach for taxpayers to obtain complete and certain relief from double taxation is to follow the Mutual Agreement Procedure (MAP) of the tax treaties. This involves formally requesting competent authority assistance.
Using the same $1-million adjustment example: To obtain relief from double taxation, the Canadian taxpayer must make a request for Canadian competent authority assistance, and its related US entity must make a similar request to the US competent authority. These two competent authorities will then review and evaluate the submissions and reassessment, before negotiating and mutually agreeing to a resolution that will eliminate double taxation. This resolution could be to provide corresponding relief to the affected entity (in this example, the US entity), to direct the CRA tax office to vacate the original reassessment, or a combination thereof.
In the last three years, the average time for the completion of the competent authority process involving the Canadian competent authority ranges from 20 to 32 months. During this process, a taxpayer’s cash may be tied up, because the CRA has the ability to collect at least 50% of the Part I tax, interest, and penalties arising from the transfer pricing reassessment, and 100% of the Part XIII tax and interest owing (the secondary adjustment of a transfer pricing reassessment).
Understanding the complexities of the process
The competent authority process can be complex, and there are some deadlines and responsibilities of which taxpayers need to be aware. Failure to comply may prevent relief from double taxation.
Preparing the submission
Information Circular 71-17R5, Guidance on Competent Authority Assistance under Canada’s Tax Conventions (IC 71-17R5), provides the CRA’s guidance on how Canadian taxpayers should prepare and submit a request for assistance. There are 17 items that must be included or specifically addressed in the competent authority submission.
The competent authority process provides an additional avenue to battle (and overturn) the initial reassessment since the submission must include “the taxpayer’s view on any possible bases on which to resolve the issues.” After reviewing the taxpayer’s submission and understanding the facts, the Canadian Competent Authority has, in some cases, directed the local CRA tax office to vacate the reassessment. Therefore, taxpayers should view the competent authority process as an opportunity to further defend the original filing position, as opposed to simply just seeking relief from double taxation.
Each tax treaty is unique, with different time limits for which tax authorities can impose adjustments and for which taxpayers must notify and request competent authority assistance for relief from double taxation.
For many of Canada’s tax treaties, the deadline to seek assistance is generally two to three years from the date of the reassessment that resulted in double taxation. However, there are some treaties, including the Canada-US Treaty, where the onus is on the taxpayer to notify the competent authorities of the need for assistance within six years after the end of the taxation year in question. It is the taxpayer’s responsibility to notify the Canadian and US competent authorities, regardless of whether the CRA has completed its audit and issued a reassessment. If the taxpayer does not make notification within the six-year period, the competent authorities are not required to accept the file and provide the taxpayer with relief from double taxation.
Moreover, when it comes to seeking assistance from the Canadian competent authority, the onus is on the Canadian taxpayer to ensure that the taxation years affected are not, or do not, become statute-barred. The Canadian competent authority states that it has no basis to provide relief if the taxation year is statute-barred. For a CRA-initiated transfer pricing adjustment, Canadian taxpayers will generally file a protective notice of objection in conjunction with a competent authority submission in respect of the reassessed years, and thus keep the years and options open. For an adjustment initiated by a foreign tax authority, however, the Canadian taxpayer may have to file formal waivers to prevent the years from becoming statute-barred.
Therefore, it is important for taxpayers to monitor the notification and competent authority submission filing deadlines and other requirements.
Odds of success
When considering options for resolving transfer pricing disputes, taxpayers often assume that they will at a minimum obtain relief from double taxation. And it’s a fair assumption—in 2012-2013, for example, 92% of all taxpayers received full relief from double taxation in MAP cases involving the CRA. This record will potentially improve as cases commencing after December 2010 will qualify for the new arbitration provision of the Canada-US treaty.
However, not all countries have well established competent authority divisions. For some countries, even where the tax treaty includes mutual agreement procedures, the foreign jurisdiction may not respond to the request for competent authority assistance.
In short, relief from double taxation cannot be assumed in all cases.
There are no shortcuts
With 17 different items to address in a competent authority submission and the length of time for the process to bring about a resolution, taxpayers may be tempted to ignore the competent authority process by just filing amended tax returns to apply the transfer pricing adjustment in the foreign jurisdiction. They should be warned, however, that the CRA and the IRS (as well as many other tax authorities) make it clear that taxpayers are not to try and attempt to shortcut the competent authority process. Also, the tax legislation in Canada places limits on the taxpayer’s ability to amend tax returns already filed to reduce income in respect of transfer pricing adjustments. In other words, bypassing the process may lead to double taxation.
Competent authority vs. the appeals process
Taxpayers need to be aware of the limitations of competent authority if they decide to battle the reassessment by appealing to the CRA. If a decision is rendered through the formal appeals process, and the taxpayer then decides to try to seek relief from double taxation, such relief may not materialize—this is because the Canadian competent authority will only present the appeal decision to the other jurisdiction’s competent authority—it will not negotiate the issue. Hence, after the audit is complete, taxpayers need to decide if they will battle the reassessment through the appeals process or through competent authority.
The ACAP process – potential benefits
The Accelerated Competent Authority Procedure (ACAP) is a process wherein the competent authorities address the transfer pricing issue not only for the years for which a reassessment has been issued, but also for the subsequent filed taxation years. Here’s an example: Let’s say the CRA disagrees with the management fee charge for 2010 and issues a reassessment. The management fee charge is calculated in the same manner in years 2011 and 2012. In the ACAP process, the competent authorities would deal not only with 2010, but also with 2011 and 2012.
Taxpayers may want to consider ACAP, as it can be very advantageous from a certainty and cash flow perspective in some circumstances. However, taxpayers must request ACAP when they make their original competent authority submission—it cannot be requested after the fact. Therefore, taxpayers must evaluate the benefit of ACAP prior to making their competent authority submission.
Navigating transfer pricing disputes
This article summarizes just a few of the tips and traps related to transfer pricing disputes. Taxpayers would be well-advised to learn more, and to be proactive. Although competent authority is a government-to-government process (the competent authorities of each country review and evaluate the submission, draft and exchange position papers, and negotiate with each other), if taxpayers are seeking the reduction or entire reversal of a reassessment, they should try to get—and stay—involved in the process. It is best practice to maintain regular communication with competent authority officials, rather than filing the competent authority submission and waiting for word on resolution.
Gordon Denusik is a partner with KPMG LLP’s Global Transfer Pricing Services Team in Vancouver.
Jason Evans is a senior manager with KPMG LLP’s Global Transfer Pricing Services Team in Vancouver.
- The Organisation for Economic Co-operation and Development (OECD) launched its BEPS Action Plan in July 2013 at the request of the G20 finance ministers. The Action Plan identifies 15 actions needed to address BEPS, with deliverables scheduled in three phases between 2014 and 2015. (www.oecd.org/tax/beps)
- The OECD released its Revised Discussion Draft on Transfer Pricing Aspects of Intangibles for commentary on July 30, 2013. (www.oecd.org/tax/transfer-pricing/comments-intangibles-discussion-draft.htm)
- McKesson Canada Corp. v The Queen (2013 TCC 404); Teletech Canada Inc. v. Minister of National Revenue (2013 FC 572).
- Gordon Denusik, CA, “Transfer Pricing Audits Present Unique Challenges,” Beyond Numbers, May 2011, pages 20-23. (https://www.bccpa.ca/CpaBc/media/CPABC/Legacy/Profiles%20and%20Publications/ICABC%20Beyond%20Numbers%20PDFs/bn_may2011.pdf)
- Gordon Denusik, CA, and Jason Evans, “Transfer Pricing: Latest Status Report,” Beyond Numbers, June/Summer 2012, pages 26-27. (https://www.bccpa.ca/CpaBc/media/CPABC/Legacy/Profiles%20and%20Publications/ICABC%20Beyond%20Numbers%20PDFs/bn_jun2012.pdf)
- IC 71-17R5, paragraph 18q.
- For the US, the tax rules disallow such downward adjustments in years for which tax returns have already been filed.
- If the decision is to go through competent authority, it is still generally advisable to file a corresponding protective notice of objection.