This article provides a brief overview of Canada's advance pricing arrangement ("APA") program. Canada's APA program has existed for over two decades. An APA is an arrangement between the Canada Revenue Agency ("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. The program 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.
Canada's APA program
The Competent Authority Services Division ("CASD") of the CRA is responsible for administering and negotiating all APAs, including requests for unilateral APAs. While audit staff will participate, the APA program is generally separate and distinct from the audit function. An APA generally attempts to resolve transfer pricing issues for future years. In contrast, audit involves a review of the taxpayer's prior taxation years.
Although an APA is generally prospective and applies to future taxation years, a taxpayer may request that the terms of the APA apply retroactively to prior taxation years that are not statute barred (i.e. open taxation years). The CASD will usually consider a "rollback" of the APA to such prior taxation years where the facts and circumstances in such prior period are the same as for the proposed APA term, the appropriate waivers are filed to extend the assessment period for such taxation years, and no request has been made by the CRA to the taxpayer to review contemporaneous documentation under section 247 of the Act (i.e. as long as those filed taxation years have not already been selected by CRA for audit). The reason for the latter condition is that an APA provides penalty protection and such protection would not be appropriate if the request for an APA rollback was received by the CRA after the CRA had contacted the taxpayer to initiate a transfer pricing audit. The relevant local tax services office ("TSO") and the foreign tax administration must also agree to the "rollback." A request for contemporaneous documentation will not be made once a rollback request has been made. The request for the rollback is separate from the request for an APA and must be specifically raised by the taxpayer with the CASD. A rollback is not available for a unilateral APA.
A taxpayer may request either a unilateral, bilateral or multilateral APA. A unilateral APA is only effective for Canadian income tax purposes. A bilateral APA ("BAPA") is available where the transfer pricing issue arises with a jurisdiction with which Canada has a tax treaty and involves an agreement negotiated between the Canadian competent authority and the competent authority of the relevant foreign jurisdiction under the applicable Mutual Agreement Procedure ("MAP") article. A multilateral APA ("MAPA") arises where the transfer pricing issue involves Canada and two or more treaty jurisdictions. As can be imagined, it is more difficult to complete a MAPA, as more stakeholders are involved. In general, the CRA prefers that the taxpayer request a BAPA or MAPA. In practice, the bulk of Canada's APAs have been bilateral APAs. If the request is limited to a unilateral APA, the CRA requires that the taxpayer include the reason for such limit if the transactions involve jurisdictions with which Canada has a tax treaty. In such circumstances, the CRA may inform the relevant treaty partner that it has accepted a unilateral APA request.
The APA process
The process for applying for an APA and issues related to the process are set out in Information Circular IC-94-4R ("APA IC"). An APA request is initiated by the taxpayer. While CRA audit may in some circumstances suggest consideration of an APA, the program is voluntary and there is no legal requirement to enter an APA. The program is open to cases involving transfer pricing issues arising from current transactions and specified future transactions that are not hypothetical. An APA request can also be made for issues similar or related to transfer pricing, such as the attribution of income to a permanent establishment. An APA is not available for transfer pricing or valuation issues arising in connection with business restructurings or reorganizations.
An APA that is in good standing is binding on the CRA and the taxpayer in accordance with its terms, conditions and qualifications. Where the taxpayer complies with the terms of the APA, the CRA will not adjust the taxpayer's transfer pricing positions under section 247 of the Act on an audit of the covered transactions during the term of the APA or apply the penalties under that provision. The request for the APA, however, is itself not a basis for avoiding the transfer pricing penalties under that provision. In addition, the taxpayer has the option not to follow the APA, in which case the transactions are open to audit and the adjustment of the transfer pricing actually used.
Where only a unilateral APA is in place, double taxation may arise as a result of a transfer pricing adjustment in the foreign jurisdiction. In those cases, the taxpayer retains the right to request assistance from the Canadian competent authority under the MAP of an applicable treaty. Where the negotiation of a BAPA or MAPA was initiated, but not concluded because the other tax authority did not accept the methodology agreed on in Canada, it is unlikely that the other tax authority's position will change where the same issue is raised again under the MAP. The Canadian competent authority may, however, negotiate an adjustment with the foreign tax authority that deviates from the terms of the unilateral APA. While the taxpayer is not bound to accept such a settlement, any adjustment negotiated by the Canadian competent authority that is agreed to by the taxpayer will prevail over the terms of the unilateral APA.
Administration of an APA after it has been issued
The CASD also plays an ongoing role in the administration of the APA. The APA will generally provide that the taxpayer file an annual report with the CASD describing the taxpayer's actual operations for the year and that it complied with the terms and conditions of the APA, including providing all the information required by the APA. Those information requirements will differ depending on the circumstances of each case. As well, the time for filing the report may also vary from case to case. For a BAPA or MAPA, there may also be provisions for a joint report. The report should be filed with the CASD within the period specified in the APA. Failure to file the report may result in the APA being revoked.
The report is reviewed by both the CASD and CRA audit at the local TSO. In general, CRA audit will look to whether the taxpayer has complied with the APA, including whether the material representations and related submissions remain valid or accurately reflect actual operations, the transfer pricing methodology agreed upon in the APA has been properly applied to the actual transaction carried out, that the calculations are accurate, and that the critical assumptions underlying the APA remain valid. Based on this review, CRA audit may propose adjustments to the taxpayer's reporting of the covered transactions. The need to make adjustments does not affect the validity of the APA. Such adjustments are reviewed with the CASD, which will determine if they are consistent with the terms of the APA or whether they require changes to the APA. After such consultations, CRA audit may propose the adjustments to the taxpayer. The APA will generally include provisions for compensating adjustments in such circumstances. The need for compensating adjustments may also arise for normal and routine adjustments from, for instance, mathematical errors, or adjustments proposed by the foreign tax authority. If the taxpayer does not agree with the proposed adjustment, it may ask the CASD for revisions to the APA.
The CASD will also generally review the ongoing status and validity of the APA, including whether it should be amended, cancelled or revoked. The circumstances in which an APA may be amended, cancelled or revoked are set out in the APA IC. In general, an APA may be amended if it is established that there has been a failure of a critical assumption, applicable law or circumstances or the APA in the foreign jurisdiction is not consistent with the Canadian APA or has been revised, cancelled or revoked. Amendments to the APA can only be made if accepted by the taxpayer. An APA may be revoked if it is established that the taxpayer made a material misrepresentation in the APA process, the taxpayer failed to comply with a material term or condition of the APA or the APA in the foreign jurisdiction has been revised, cancelled or revoked. An APA may be cancelled if it is established that the taxpayer has made a material misrepresentation, the taxpayer failed to comply with a material term of the APA, there was a failure to meet a critical assumption, there has been a change in law, the APA in the foreign jurisdiction is not consistent with the Canadian APA or has been revised, cancelled or revoked, or there has been a failure to conclude a revised APA, BAPA or MAPA. The cancellation of an APA is effective as of the beginning of the taxation year in which the reason for the cancellation arose. In contrast, the revocation of an APA is effective retroactively back to the beginning of the term of the APA.
The CASD is also responsible for processing a request to renew an APA. The renewal procedure is generally the same as for the initial request for an APA, including the requirement to provide the same (and updated) information as in the initial submission. An APA will be renewed if the CASD is satisfied that the methodology provided in the prior APA continues to be appropriate, there has been no material change in circumstances and the taxpayer has complied with the terms of the prior APA. Where there has been a change in material circumstances or where the taxpayer believes that the prior APA no longer deals adequately with the economics of the transactions, proposed amendments to the prior APA should accompany the taxpayer's renewal request, together with the documentation to support such amendments. However, from a practical perspective, renewals take a considerable amount of time as personnel working on the APA may have changed over time, with new people viewing the functions, assets and risks differently.
Summary
APAs are most often considered where taxpayers want tax certainty regarding their pricing of certain cross-border intercompany transactions. If taxpayers have a history of contentious transfer pricing audit activity with the CRA, or they anticipate that certain inter-company transactions will be contentious if audited, it may be prudent to consider an APA. Although a drawback with Canada's APA program is that it can be a lengthy and costly process, a taxpayer can end up with significant tax and service provider cost savings compared to a CRA transfer pricing audit followed by an arduous dispute resolution process. Taxpayers should discuss the merits of an APA with their tax advisors.
Finally, there is anecdotal evidence in recent years that the CASD is becoming more and more reluctant to issue acceptance letters on APAs until the methodologies in the APA submission are more in line with what the CRA would consider "acceptable" (i.e. perceived as being a position that is fair from a transfer pricing perspective). This trend is likely, in part, because a company's position is shared with the CASD and the foreign competent authority and will form the basis for negotiations. Once the die has been cast, it is difficult for the CASD to present and defend a different approach in negotiations. And, with binding arbitration with more treaty partners, the CASD may have concerns they are losing final say on the final methodology. If this trend continues and the reasons are wholly or partly due to concerns outlined above, this would be highly unfortunate since the objective of seeking an APA is to resolve these complex transfer pricing cases. This is an issue that should be discussed with tax advisors, before a decision to proceed with an APA request is made.