On Feb. 21, 2024, the Canada Revenue Agency ("CRA") published Information Circular 94-4R2 International Transfer Pricing: Advanced Pricing Arrangements (APAs) (the "Revised Circular"). An APA is an arrangement between the CRA and the taxpayer that covers specific transactions between the taxpayer and related non-resident entities. The APA confirms an agreed upon transfer pricing methodology, in advance, for cross-border transactions between the parties covered by the APA for specific periods of time based on certain assumptions and on specified terms and conditions. In brief, an APA allows a Canadian resident taxpayer or taxpayers and the CRA to resolve, in advance, potential transfer pricing disputes under the Income Tax Act ("Act") and Canada's tax treaties thereby providing tax certainty on the transfer prices. The Revised Circular, which sets out the CRA's policies and guidelines for Canada's APA program, replaces Information Circular 94-4R ("Former Circular"), issued March 16, 2001, and Information Circular 94-4RSR (Special Release), issued March 18, 2005, for small businesses.

Background and context

Many of the changes in the Revised Circular were expected. The CRA's APA program had recently been a part of a public consultation process and the CRA had circulated a draft of the Revised Circular to certain external parties in June 2023. Some concerns raised by the tax community about the Revised Circular during the consultation process were addressed in the Revised Circular, but many weren't.

The changes to the Revised Circular are significant and will cause many taxpayers to forgo applying for an APA. In the long run this will result in more audit activity and lengthy (and costly) tax dispute resolution processes for Canadian companies who have complex transactions with related non-resident entities. This is an unfortunate outcome for taxpayers seeking tax certainty and penalty protection. Additionally, one would expect that issues arising from complex intercompany transactions would be best resolved in a transparent and cooperative process between a taxpayer and the two relevant tax administrations like the APA program.

Over the past several years, the Competent Authority Services Division ("CASD") of the CRA has been gradually tightening access to its APA program. The changes to the Revised Circular, which are largely focused on the criteria that must be met for taxpayers to be accepted into the APA program, are consistent with CASD's evolving internal policies over that period. The Revised Circular specifically states that "The aim of this guidance is to provide increased transparency with respect to the CRA's APA program by offering clear direction to taxpayers on the APA process and program requirements." Although limiting access to the APA program is disappointing, the "transparency" is a positive feature since it will weed out, before taxpayers incur significant APA submission costs, those obvious cases that are not appropriate for the APA program. The Revised Circular also reminds the public that the APA program "is a discretionary service" provided by the CRA and that it has "no legal requirement to enter into an APA" and there is "no statutory framework for APAs." The transparency regarding eligibility for the APA program and the CRA's comments regarding the discretionary nature of the APA program may be intended to increase the CRA's ability to defend an application for judicial review to the Federal Court for those cases rejected from the program (we understand that at least one such application has been made and is currently before the Federal Court).

Changes at a glance

The Revised Circular lists several general scenarios where the CRA may decide not to proceed with an APA request. Again, this is presumably to discourage taxpayers with intercompany transactions that fall within these scenarios from even considering the APA program and submitting a pre-filing package. Here are a few of those scenarios:

  • The CASD has concerns that the covered transactions are part of or related to tax avoidance or base erosion and profit shifting ("BEPS") strategies.
  • Before the APA term the business underwent a transformation (including business restructuring, shifting or elimination of functions, transferring assets, closing plants, etc.) with significant tax implications that have not been previously audited by CRA.
  • During the APA term the business is expected to undergo a significant transformation.
  • Levels of working capital, assets and liabilities are not expected to stay consistent during the APA term (ignoring inflation or significant changes in the global economy).
  • The business has not been carried on long enough to complete an economic analysis covering a full business cycle of taxation years for which tax returns have been filed.
  • The taxpayer cannot establish a compelling commercial rationale for holding an intangible in a jurisdiction separate from the entity in which the intangible was developed.
  • The ownership and development of the intangibles is unclear.
  • The taxpayer cannot establish the value of an intangible, making it unlikely that the CASD could justify any valuation.
  • The taxpayer chooses not to include all cross-border intragroup transactions in their request without sufficient reasons.
  • The legal contracts are not aligned with the actual conduct of the parties.

The Revised Circular also lists scenarios where the CRA may decide not to proceed even after it has received a formal APA submission:

  • The formal submission did not address CASD's concerns or requests raised earlier in the APA process (e.g., during a pre-filing meeting).
  • The business conditions and the facts and circumstances of the taxpayer have changed significantly since the APA conditions letter was issued by the CRA.
  • The taxpayer has not responded or has not responded in a timely manner to CASD's requests for more information during the APA process.
  • The CASD determines that key information in the submission is incorrect, incomplete or misleading.

Although the stated main purpose of the Revised Circular is for the CRA to be as transparent as possible regarding eligibility for the APA program, it also introduces other significant changes to the APA process, including the following:

  • More details have been added regarding the procedures and preliminary information required by the CASD for the pre-file meeting.
  • The taxpayer will now receive a written explanation from the CASD if it decides not to proceed after the pre-file meeting.
  • The CASD does not set a definitive timeline to establish a date for a pre-filing meeting once a submission in respect of that meeting is made. Previously, the CASD required the submission to be made at least two weeks before any possible pre-file meeting date.
  • A request for a renewal should now be made in the final year of an existing APA. Previously the request had to be made no later than nine months before the existing APA expired.
  • The fixed $5,000 administrative fee for the small business APA program was removed. No other material changes to the small business APA program appear to have been made.
  • The Revised Circular explains the interaction of the Canada-U.S. arbitration procedure to the APA process where an APA settlement is not reached within certain a certain timeframe.

Impact of the Revised Circular on the APA program

Although the Revised Circular does not require the CASD and the taxpayer to agree on the proposed transfer pricing method ("TPM") in order to be accepted into the APA program, which was a scenario initially proposed during the consultation process, the nature and volume of the listed scenarios to reject an APA request are broad and subjective. These criteria will often give the CASD the flexibility to reject cases from the APA program where it has concerns about the taxpayer's chosen TPM. Consequently, we are concerned that CASD will continue to be reluctant to issue acceptance letters on APAs until the methodologies in the APA submission are more in line with what the CRA would consider to be a fair transfer pricing position. Although arbitration exists in many of these APA processes, the CRA would rather avoid a potential confrontation on those more complex cases and risk losing control of the outcome. For example, once an APA request is accepted and a taxpayer's position is shared with the CASD and the foreign competent authority and forms the basis for negotiations, the die has been cast. It is difficult for the CASD to present and defend a different approach in negotiations. The Revised Circular clearly provides the CRA with the flexibility to reject more contentious cases from the program, therefore achieving greater control over the outcome of the APA.

What's missing from the Revised Circular is also concerning. For example, it would have been helpful if the CRA had included some examples of i) business transformations that would not be considered significant enough to impact a taxpayer's eligibility for the APA program, and ii) scenarios that would not generally be considered to be related to tax avoidance or BEPS. In the latter case, for example, how would the CASD view a foreign entity formed in a jurisdiction to take advantage of a patent box regime that is compliant with the 2015 Final Report on Action 5 of the Action Plan on BEPS, including the requirements in respect of the "nexus approach" that aligns access to tax benefits with substantial R&D activities and expenditures in the jurisdiction that gave rise to that IP income? Lastly, it's disappointing to see that there was no commitment from the CRA to leverage the work they do in the initial APA to help streamline or expedite APA renewals. Namely, the pre-file process remains onerous and functional interviews are still required.

Conclusions

Taxpayers are going to have to be extremely careful before choosing to proceed with an APA request. If there is any potential area of contention, it may be difficult to get CASD to accept the taxpayer into the APA program. Moreover, the time and costs of an APA submission, or even a pre-fling submission, can be significant. As a result of the Revised Circular, taxpayers not only need to consult their tax advisors on whether an APA would benefit them, they must now carefully consider the likelihood of being accepted into the APA program in the first place. It's an unfortunate change that stands at odds with the APA program's purpose of providing taxpayers with complex intercompany transactions the opportunity to seek tax certainty and avoid long and contentious audits. Put differently, the kinds of business models and intercompany transactions that are now more likely to be eligible for an APA program because they lack complexity are precisely those that benefit least from the APA program since they tend not to be subject contentious audits. The Revised Circular's overriding concern with restricting access to the APA program raises an uncomfortable question: If the most complex cases don't belong in the APA program, why have an APA program at all?

If you have any questions about the APA program, please contact a member of our Tax or Transfer Pricing groups.