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Proposed Canadian advance pricing agreement information circular.

On July 29, 1993, Tax Executives Institute submitted the following comments on a draft Information Circular containing guidelines for the Advance Pricing Agreement process in Canada. The comments--which were submitted to Carole Gouin-Touissant, Director, General, International Tax Programs Directorate for Revenue Canada, Customs, Excise and Taxation--were prepared under the aegis of TEI's Canadian Income Tax Committee, whose chair is Vincent Alicandri of Xerox Canada.

On May 21, 1993, Revenue Canada-Customs, Excise and Taxation issued an exposure draft of an information circular (IC) relating to procedures and guidelines for securing an Advance Pricing Agreement (APA) to confirm that a taxpayer's transfer pricing methodology and results will satisfy the requirements for dealing with related parties as though at arm's length. Tax Executives Institute is pleased to submit the following comments on the draft of the proposed information circular.


Tax Executives Institute, Inc. is an international organization of approximately 4,800 professionals who are responsible--in an executive, administrative, or managerial capacity-for the tax affairs of the corporations and other businesses by which they are employed. TEI's members represent more than 2,400 of the leading corporations in Canada and the United States.

Canadians make up approximately 10 percent of TEI's membership, with our Canadian members belonging to chapters in Calgary, Montreal, Toronto, and Vancouver, which together make up one of our nine geographic regions. In addition, a substantial number of our U.S. members work for companies with significant Canadian operations. In sum, TEI's membership includes representatives from most major industries, including manufacturing, distributing, wholesaling, and retailing; real estate; transportation; financial; and natural resources (including timber and integrated oil companies). The comments set forth in this submission reflect the views of the Institute as a whole, but more particularly those of our Canadian constituency.


TEI commends Revenue Canada for proposing such an innovative procedure as the Advance Pricing Agreement (APA) to reduce potential controversies surrounding transfer pricing methodologies (TPM). The Institute has participated in the development of an APA procedure in the United States, and is pleased to have a similar opportunity with respect to the Canadian procedure.(1) For many taxpayers, obtaining an APA will doubtlessly reduce the uncertainty in ascertaining whether a particular price will be deemed to satisfy the requirement of dealing with related parties as though at arm's length. In the comments that follow, TEI sets forth its specific recommendations to improve the Information Circular (IC) and provide taxpayers with adequate information to assess whether to pursue an APA. Our comments generally follow the organization of the IC.


Paragraph 1 of the IC states that an APA is designed to prospectively confirm an appropriate transfer pricing methodology. To allay taxpayer concerns relating to the treatment of related-party transactions in prior open taxation years, we recommend that Revenue Canada's policy on the retroactive application of the APA methodology be set forth as part of the Introduction, as well as in several of the detailed provisions (discussed below).

Paragraph 2 of the Introduction states that the IC is not meant to be exhaustive and that more detailed information will be made available during pre-filing meetings between the taxpayer and Revenue Canada. We recommend that the scope of the circular be reconsidered and that substantially more detailed information be provided as part of the IC to enable taxpayers to determine whether to even commence the APA process.

Finally, inasmuch as the Customs, Excise, and Taxation departments of Revenue Canada have now been combined, we suggest that consideration be given to extending the APA procedure to customs and excise matters.

Purpose and Scope of APAs

Paragraph 6 of the IC provides that the APA will only apply to future transactions for a specified period of time. TEI believes that under certain circumstances Revenue Canada and a taxpayer may wish to apply the terms and conditions of an APA retroactively to open taxation years. Retroactive application should only be effected, however, by agreement with the taxpayer, not as a matter of course. That is, Revenue Canada should confirm that information submitted in connection with the APA (or indeed the APA itself) may not be invoked by auditors as a means of proposing transfer price adjustments in respect of prior years.2 Nonetheless, where at the time of application for an APA a controversy exists with Revenue Canada concerning the propriety of a taxpayer's TPM, the IC should not preclude the taxpayer from proposing (or Revenue Canada from accepting) a settlement of open taxation years based on terms similar to the APA.

At a minimum, we recommend that this section state whether Revenue Canada will attempt to apply the TPM proposed for the APA to open taxation years. Taxpayers should be advised whether the illustrative information demonstrating the results under the TPM in the three preceding taxation years will be used by auditors of Revenue Canada to determine the reasonableness of the intercompany pricing methodology employed during that three-year period. Again, we recommend that Revenue Canada eschew the use of the illustrative information for such a purpose. Without such assurances, taxpayers may not avail themselves of the APA service.

The APA Process: An Overview

Paragraph 8 of the IC states that the taxpayer should propose a suggested time period for which the transfer pricing methodology will apply. To assist taxpayers in preparing for the pre-filing meetings, we recommend that the IC provide general guidance on a range of years that Revenue Canada believes an APA might properly cover. Taxpayers that desire shorter or longer APAs, however, should be afforded the opportunity to demonstrate why their proposed term of years should be accepted.

In paragraph 9, the IC states that the foreign-related party participating in the transactions that are the subject of the APA should ask the tax administration in its country to draw up a comparable agreement using the same TPM. TEI agrees that bilateral agreements are necessary to eliminate double taxation of the same income. We recommend that Revenue Canada make the negotiation of bilateral APAs a high priority. Ideally, the foreign tax administration should be a party to the APA agreement. We recognize, however, that it may not always be possible to reach a bilateral agreement. Consequently, we encourage Revenue Canada to remain open to providing a taxpayer with a unilateral APA, on the grounds that even such an agreement could provide the taxpayer with a modicum of certainty within Canada.

Paragraphs 8 and 12 of the IC state that the proposed TPM must produce "arm's-length results" or meet the "arm's-length standard," which is to be demonstrated using "reliable data" supported by "available" internal documentation. In many or most cases, taxpayers seeking an APA will be using secondary methods of determining "reasonable arm's-length prices" as defined in paragraph 16 of IC 87-2. The differences in wording suggest that a more rigorous approach to transfer pricing than that set forth in IC 87-2 may be applied in the APA process. We recommend that the guidelines include a statement confirming that the standards for demonstrating an arm's-length result includes the methods enumerated in IC 87-2.

In addition, we recommend that the IC list the types of data that are necessary to support the taxpayer's proposition that the TPM will produce arm's-length results. For example, where a taxpayer proposes to rely upon comparable third-party transactions, will Revenue Canada require additional analyses of returns on assets or returns on investment for the entities in either or both jurisdictions?

Paragraph 12 states that one requirement of the proposed TPM is that it be easily applied. Does this statement add anything of substance to the requirements? For example, assume a profit-split method is used on an estimated basis and adjusted quarterly to an actual basis. Will this method be considered "easily applied?" TEI believes that the judgment whether a method is "easily applied" may lie in the eye of the beholder.

A taxpayer seeking an APA may employ a TPM for a considerable period before the government responds to the request. To avoid problems arising from delays in the process for approval of the APA, we believe the APA should, when requested by the taxpayer, apply retroactively to transactions for the year in which the APA application is made. In addition, a mechanism should be established for amending the TPM agreed upon in the APA should the foreign jurisdiction and Revenue Canada agree to a TPM that is different from that agreed upon between Revenue Canada and the taxpayer.

Paragraph 11 provides that the proposed TPM must comply with section 69 of the Income Tax Act and with the provisions of IC 87-2. The proposed regulations on transfer pricing in the United States propound a new pricing methodology (i.e., comparable profits method) not specifically covered under IC 87-2. Therefore, we recommend that the IC include a discussion of Revenue Canada's view on the use of pricing methods that may not be covered under IC 87-2.

Pre-Filing Meetings

Paragraph 13 of the IC states that the taxpayer may request "one or two pre-filing meetings." Because of the complexity of the transactions and issues involved in evaluating pricing issues-and the fact that the APA service is in its introductory stage--we believe that more than one or two meetings will be necessary. The circular should recognize this fact and adopt a more flexible approach regarding pre-filing meetings.

Dismissing an APA Request

Paragraph 15 sets forth the characteristics of cases that Revenue Canada deems important to resolve through the APA process. To our mind's eye, many of the listed characteristics relate to relatively straightforward transactions under reasonably "safe" interpretations of the Canadian Income Tax Act. Hence, taxpayers generally will not need an APA for this type of transaction. The principal benefit of an APA arises where the transaction is complex, where the foreign country is difficult to deal with, where the most favourable position is controversial, or the goods or intangibles are unique. We believe that Revenue Canada must be willing to deal with these situations if the APA is to be successful.

The IC provides that one of the characteristics which Revenue Canada will consider in determining whether to review an APA request is the potential application of the APA to similar companies in a major industry. We believe that this particular characteristic may be difficult to gauge because the circumstances of each company even within the same industry may differ. TEI believes that the circular should confirm that the TPM of one group of companies under an APA will not necessarily be applied to the industry as a whole. In our view, any policy (or methodology) that Revenue Canada desires to apply to an entire industry should be developed in consultation with the members of that industry. The first company in an industry to the APA finish line should not be able to impose its TPM on its competitors. Accordingly, this characteristic should not be a major factor in determining whether a particular APA request will be reviewed.

Another characteristic the IC says that Revenue Canada will consider is whether the transactions to be covered under the APA comprehend all related cross-border transactions between the applicant and the relevant foreign-based related entity. This broad requirement may encumber the APA process with a condition far too onerous for sophisticated businesses with myriad cross-border, related-party transactions. Although this requirement may be proper where various transactions are integrally linked, we recommend that there be sufficient flexibility in the process to allow companies to apply for an APA for specific types of transactions without sweeping in all transactions between a set of related parties.

Paragraph 15 of the IC also states that if Revenue Canada decides to dismiss a taxpayer's application for an APA, the taxpayer must be provided with the opportunity to make representations. TEI recommends that the basis for the application's dismissal be provided to the taxpayer to enable it to make a proper representation.

Finally, the IC does not address the procedure for a taxpayer to voluntarily withdraw from the APA process. Under the APA rules in the United States, a taxpayer may withdraw its application at any time before the earlier of (i) the conclusion of a competent authority agreement, or (ii) the signing of the APA. See Rev. Proc. 9122, section 6.07, 1991-1 C.B. 526. We recommend that the IC incorporate similar rules for Canada.

User Charges

Paragraph 17 provides that the taxpayer is responsible for paying the cost of engaging any independent experts. Inasmuch as the process will benefit both the taxpayer and Revenue Canada, we believe consideration should be given to a sharing of the costs by the taxpayer and the government, or having the costs borne by the party making use of the expert.

Requirements of an APA Submission

An APA is a prospective arrangement designed to apply to future transactions. At paragraph 18, the IC states that the results of the TPM to be employed should be illustrated by applying it to the operations of the three tax years immediately preceding the application. TEI believes that applying the proposed TPM to oper.ations of the three previous years is unnecessary and, perhaps, misleading where the fundamental business may have changed. Furthermore, taxpayers desiring to modify their existing pricing arrangements may be apprehensive about entering the APA process because of this requirement. In such a case, taxpayers may be compelled to justify both their existing and proposed pricing arrangements. We recommend that APA requests should be evaluated only on the basis of projected operations for the periods to be covered by the APA. In the event that any retrospective illustration of the effect of the proposed TPM is necessary, we recommend that it be limited to a one-year lookback period. This would minimize the administrative and financial burden otherwise imposed on taxpayers.

The IC also requires the taxpayer to provide projected financial results of operations for the periods to be covered by the APA, which could conceivably be a four- or five-year period. We recommend that the projection period be shortened and that, in any event, the IC recognize that the ever-changing global environment in which multinationals operate may make it difficult to provide "accurate" forecasted data. Forecasts are only estimates based on assumptions; Revenue Canada should confirm, therefore, that any differences between the forecasted and actual results under an APA do not by themselves jeopardize the validity of the APA, most especially with respect to completed transactions. Indeed, the actual results of a company's operations and its forecasted results should be irrelevant where comparables are available and form the basis of the APA.

We recommend that more detailed guidelines on the information to be supplied by the taxpayer during the APA process be enumerated in the circular to assist taxpayers in determining whether to consider the APA procedure.

Annual APA Reports

Paragraph 21 states that annual APA reports must be filed by taxpayers. In this regard, the IC should address filing deadlines, taking into account tax return filing dates and also differences in filing deadlines of other countries. For example, the U.S. annual APA report filing deadline is 90 days after the related tax return filing deadline (including filing extensions). See Rev. Proc. 91-22, section 10.02, 1991-1 C.B. 526. A similar deadline for APA reports may be appropriate for Canada.

More fundamentally, TEI questions whether the filing of annual APA reports is necessary because the information contained in these reports will only be reviewed in the course of the regular audit cycle. In our view, the auditor will be in a position to assess whether the taxpayer has complied with the conditions of the APA. We believe that, at a minimum, the circular should provide a summary of the information to be supplied on the APA report.

Renewing or Revising APAs

Paragraph 24 provides that APAs may be renewed after taking into account whatever revisions are necessary and appropriate in light of changed facts and circumstances. Furthermore, paragraph 25 states that an APA may be revised where there is a change in critical assumptions, tax law, or a treaty provision. TEI believes that additional guidance should be provided in the IC regarding the process for renewing or revising the APA. This would facilitate the revision of APAs should it be necessary to make such revisions.

Use and Disclosure of Information

Paragraph 27 states that the information provided in the course of obtaining an APA relates to the potential tax liability of the taxpayer and, as in the case of a normal tax audit, will remain confidential and subject to the safeguards of section 241 of the Income Tax Act and the confidentiality provisions in Canada's tax treaties. Accordingly, TEI believes it is essential that taxpayers be made aware of the mechanisms in place to ensure that the information remains confidential and is only to be used in connection with the APA process.


The introduction of an APA process to prospectively resolve transfer pricing issues is a timely and welcome initiative by Revenue Canada. TEI is pleased to have the opportunity to present its views on the draft information circular relating to the Advance Pricing Agreement procedure and guidelines. Should you have any questions on our comments please call either Hugh D. Berwick, TEI's Vice President for Canadian Affairs, at (514) 848-8235 or Vincent Alicandri, Chair of our Canadian Income Tax Committee, at (416) 733-6762.

(1) For background purposes, we attach copies of the comments we have provided to the U.S. Internal Revenue Service.

(2) Thus, when the APA request does not encompass an established pricing methodology, the APA should not be construed as undermining the taxpayer's current (or prior) practice. When a taxpayer initiates an APA request for a new pricing scheme, it recognizes that, in order to obtain the certainty of an advance determination, it may have to adopt a methodology skewed in the government's favor. The taxpayer's willingness to compromise should not be viewed as an admission that its prior policies were improper.
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Publication:Tax Executive
Date:Sep 1, 1993
Previous Article:Rev. rul. 93-4 (entity classification).
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