The growth in international business has led to more Canadian companies transacting across borders with related parties, making transfer pricing an important focus of the Canada Revenue Agency ("CRA"). The CRA has invested significant resources in the area of transfer pricing which has established Canada as arguably the most sophisticated nation, and perhaps most aggressive, in international tax and transfer pricing. Furthermore, the Canadian tax system does not provide adequate measures to allow taxpayers to self-rectify filed taxation years where the transfer pricing analysis is subsequently determined to be inadequate. This increases the possibility of CRA audit action.
A taxpayer who receives a transfer pricing adjustment can contest the adjustment through the normal dispute resolution process available to all Canadian taxpayers subject to CRA reassessments, i.e., by filing a notice of objection with the CRA Appeals Directorate ("Appeals Process"). However, since a transfer pricing adjustment generally results in double taxation for the corporate group, as the adjustment generally taxes income that has already been reported in a foreign jurisdiction, an alternative dispute resolution mechanism is available through the Mutual Agreement Procedure article of Canada's bilateral tax treaties, to allow the competent authorities of the respective countries to resolve the double taxation ("Competent Authority Process" or "MAP"). The many considerations that must be contemplated by taxpayers and their advisors when deciding how to navigate the available dispute resolution avenues make transfer pricing disputes truly unique.
This article provides an overview of the various dispute resolution options that a taxpayer must consider once the CRA issues a notice of reassessment following a transfer pricing audit. While a taxpayer can decide whether to first have its file reviewed under the Appeals Process or the Competent Authority Process, this article will first examine the Appeals Process.
The Appeals Process for a transfer pricing adjustment is the same as for any other tax adjustment. Briefly, it begins with the taxpayer filing a notice of objection in response to the CRA's notice of reassessment. Following a review of the notice of objection and additional exchanges with the taxpayer's representative, the CRA's Appeals Division will render a decision and either issue a new notice of reassessment allowing the objection in whole or in part, or a notice of confirmation stating that the taxpayer's objection has been denied. Where the taxpayer is unsatisfied, it may file a notice of appeal with the Tax Court of Canada ("TCC"). Before we delve into the transfer pricing litigation process, we will first provide an overview of the Competent Authority Process.
It should be noted that the Appeals Process does not resolve double taxation unless the CRA overturns the adjustment in full. For this reason, most transfer pricing cases are worked through the Competent Authority Process, as the correlative relief afforded by the other country relieves the double taxation. However, the relief of double taxation is not always the primary focus for each corporate group, such as cases where the non-resident corporation is in a loss position or located in a low tax jurisdiction. These are some of the factors to be considered when deciding whether to first pursue the Appeals or Competent Authority Process.
Mutual Agreement Procedure and Arbitration
The MAP article in Canada's tax treaties sets out the general procedures that govern a taxpayer's request to seek resolution of double taxation. The Canadian Competent Authority Services Division ("CASD") within CRA is responsible for the Canadian competent authority program. A request for consideration by CASD is generally made by a taxpayer after a CRA international auditor has made an adjustment.
The CASD has published Information Circular 71-17R5 entitled Guidance on Competent Authority Assistance Under Canada's Tax Conventions ("Circular") which should be referred to by any taxpayer contemplating making a MAP request to the CASD. The Circular expands significantly on those general procedures described in the MAP article of the particular treaty.
When an auditor assesses an adjustment, additional tax assessed on the file begins to accumulate interest. The CASD will not negotiate the interest or penalties that result from adjustments.1 Also, a taxpayer considered to be a "large corporation" for purposes of the Income Tax Act is required to pay 50 per cent of the adjustment within 90 days of the (re)assessment. However, the CRA's Revenue Collections Branch has the discretion to accept security in lieu of payment if the taxpayer files a competent authority request.
Accelerated Competent Authority Procedure
In addition to a request under the MAP article for competent authority assistance in respect of a specific reassessment, a taxpayer may request assistance for subsequent filed taxation years on the same issue. Once an Accelerated Competent Authority Procedure ("ACAP") request has been received, the CASD will consult with the appropriate Tax Services Office to determine whether an ACAP is suitable for the taxpayer's particular circumstances. The issue must generally be one that is recurring and relevant to the specific reassessment.
Advance Pricing Arrangements
The CRA's Advance Pricing Arrangement ("APA") program assists taxpayers in determining transfer pricing methodologies with the objective of avoiding double taxation that may otherwise occur. Under the CRA's APA program, a taxpayer may request a bilateral APA with respect to specified cross-border transactions. Once concluded, bilateral APAs provide an increased level of tax certainty in both tax jurisdictions, thereby lessening the likelihood of double taxation. The term of an APA is usually three to five years (future years), but that may vary depending on the facts, circumstances and resolution of the particular case. The taxpayer may ask, or the relevant Tax Services Office may decide, to apply the terms and conditions of an APA retroactively to non-statute-barred taxation years (i.e., an APA rollback). Where APA rollbacks are accepted, the Canadian taxpayer will not be subject to transfer pricing penalties.
To enhance and expedite the lengthy competent authority process, Canada and the United States have introduced mandatory arbitration. A provision included in the 5th Protocol to the Canada-US Tax Treaty deals with arbitration of such disputes which became eligible for arbitration beginning on Dec. 15, 2010.
After a taxpayer submits all the relevant documents that the competent authorities need to negotiate the file under MAP, the competent authorities will only have 24 months to reach a resolution. After this time expires, either the US or Canadian related party can request that the case be referred to an arbitration board for consideration.
Before engaging in the arbitration process, three criteria must be met. First, tax returns must have been filed in at least one of the two countries for the taxation year(s) at issue. Second, the case must not be considered a case that the competent authorities both agree, before the date on which arbitration proceedings would otherwise begin, is not suitable for arbitration. Third, the taxpayer and all other "concerned persons" whose tax liability would be directly affected by the result of the arbitration process, as well as their authorized representatives, must agree in a written confidentiality agreement to keep all information exchanged in the process between the authorities confidential.
Once a case is in the hands of the arbitration board, the decision of the three arbitrators will be made using "baseball" arbitration, whereby the arbitrators must select one of the two proposals submitted by the two governments with no changes. Once the decision by the arbitration board is rendered and accepted by the taxpayer, the arbitration determination is binding on the two countries. In addition, the arbitration board is not subject to revision and does not have to provide an explanation for its decision. However, the taxpayer can choose to reject the final determination of the arbitration committee and thereafter pursue its rights under the Appeals Process.
The decision to proceed or withdraw from competent authority consideration lies with the taxpayer, even when the case is in the hands of the arbitration committee. Should the case be heard by the arbitration committee, the decision must be provided in writing within six months following appointment of the committee.
Early indications are that arbitration has created more incentive for the competent authorities to try and arrive at a mutual understanding and resolution of the file within the 24 month period.
Statute of Limitations for Appeals Process or Litigation
A taxpayer's decision to proceed with the Competent Authority Process does not "stop the clock" on the applicable statute of limitations for the Appeals or litigation process. Accordingly, taxpayers who choose the Competent Authority Process route should always protect their rights of appeal by filing a notice of objection against a reassessment and requesting that the Appeals Branch hold the notice of objection in abeyance, pending resolution of the issues by the competent authorities. Although in most cases the competent authorities reach agreement and relieve taxation not in accordance with the tax convention, there is no further recourse2 if the taxpayer has not protected its domestic appeal rights. Failure to request that the objection or appeal be held in abeyance could result in the termination of the Competent Authority Process. However, a taxpayer may make a competent authority request regarding one issue of a reassessment and independently pursue another issue with the Appeals Branch.
Conversely, if a taxpayer decides to pursue the Appeals Process or litigation first, it should always file its competent authority request within any treaty time limits stipulated under the MAP article and then request the CASD to hold that MAP request in abeyance pending the results of the notice of objection or appeal. Where the taxpayer believes that taxation not in accordance with the tax convention remains following an Appeals Branch decision, the taxpayer can submit the issue for competent authority consideration, or if already submitted, ask that the Competent Authority Process recommence. However, if the Appeals Branch decision has the concurrence of the taxpayer, the CASD will only present the case to the other competent authority and will not negotiate the issue. If the taxpayer does not concur with the Appeals Branch decision, the CASD will negotiate the issue. The CASD will give due consideration to the findings made by the Appeals Branch with regard to the application of Canadian law.
Transfer Pricing Litigation
Given the many avenues to resolve transfer pricing disputes and given that, barring a 100% reversal of the reassessment, double tax can only be resolved through the MAP process, only a handful of significant transfer pricing cases have been brought before Canadian courts. However, this trend has slowly changed in recent years as more transfer pricing cases are working their way through the courts.3 For cases that require litigation, two procedural options, the informal and general procedure, are available to taxpayers who file a notice of appeal with the TCC. However, given that the quantum of transfer pricing adjustments are generally significant, we are unaware of any transfer pricing cases that have been heard under the informal procedure. Following the determination of the TCC, appeal routes lie to the Federal Court of Appeal and finally to the Supreme Court of Canada with leave where the issue is one of national importance.
When preparing for a transfer pricing hearing, the taxpayer must understand that Canadian courts adopt a reverse onus policy for tax and transfer pricing cases. The facts alleged by the CRA are assumed to be correct and it is the taxpayer's onus to demolish those assumptions of fact. The Crown has the ability to plead these "assumptions", which are up to the taxpayer to disprove. Full document disclosure is not required in tax litigation. However, through access to information and privacy legislation, tax advisers are able to obtain information such that the taxpayer and its advisers should be in a good position to properly prepare for the upcoming litigation. Taxpayers may also request documents from a tax official who may release such documents within the parameters of section 241 of the Income Tax Act.
The taxpayer will be subject to an examination for discovery, the purpose of which is to gain admissions or an understanding of the Crown's case. A pre-hearing conference will also be held and presided over by a TCC judge, which allows the parties to get an objective view of the merits of their respective cases. If a settlement offer is made and the case proceeds to a judgment that meets or beats the terms of the settlement offer, the party who made the offer is entitled to an enhanced cost award from the date of the offer.
With many transfer pricing dispute resolution or tax planning options available to multinational corporate groups with entities in Canada, it is important for taxpayers to seek the assistance of transfer pricing professionals to map out the best course of action for the particular entity. The Gowlings Transfer Pricing and Competent Authority Group can assist taxpayers with all Canadian transfer pricing matters, whether for tax planning or dispute resolution purposes. After all, proper planning is often the key to successful dispute resolution.
1 However, as would be the case with the Appeals Process, the taxpayer may be entitled to interest relief for any unreasonable delays during the Competent Authority Process.
2 Ignoring arbitration under the Canada-US Tax Convention when an agreement cannot be reached.
3 See for example McKesson v. The Queen (2014 TCC 266), Marzen Artistic Aluminum Ltd. v. The Queen (2014 TCC 194), Canada v. GlaxoSmithKline Inc. (2012 SCC 52), Alberta Printed Circuits Ltd. v. The Queen (2011 TCC 232) and The Queen v. General Electric Capital Canada Inc. (2010 FCA 344).