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The effect of the APA and other U.S. transfer-pricing initiatives in Canada and other countries.

I. The Current Controversies in Transfer Pricing

A. Overview

In transfer-pricing matters, the United States can be likened to a benevolent dictator, stirring controversy by giving with one hand and taking with the other. The latter may be seen to characterize the "super royalty" provision of section 482 of the Internal Revenue Code (which was enacted in 1986)(1**) and the ensuing "White Paper" on transfer-pricing,(2) the compliance requirements of section 6038A, et seq., the recent proposed transfer-pricing regulations,(3) and the recent legislative proposals set forth in H.R. 5270.(4) The former may be seen to characterize the Advance Pricing Agreement (APA) initiative.(5)

This article examines the reaction in Canada and certain other countries to the APA initiative in the context of the other (controversial) U.S. developments just noted, particularly the section 482 regulations and H.R. 5270.

At a recent seminar conducted by the Canadian Branch of the International Fiscal Association,(6) Philip Morrison, then-International Tax Counsel to the U.S. Treasury, listened patiently to criticisms levied at the proposed section 482 regulations. It was suggested that the regulations clearly violate the norms and principles underlying the so-called arm's-length principle as generally understood and, indeed, as given its initial recognition, format, and substance by the United States itself.

Mr. Morrison responded to the criticisms by carefully explaining that, quite apart from the Administration's view that no such departure from the arm's-length principle really arises from the proposals' requirement for the use of an ex post facto bottom-line orientated approach (inherent in the comparable profit method), the regulations' writers really had no choice. In enacting the super royalty, Congress had mandated the development of pricing rules that ensure the most appropriate allocation of profit between members of a multinational and, if necessary, these rules are to be based on global profit factors rather than transactional (analysis) factors. If these rules violate the essential characteristics of, or principles underlying, arm's-length pricing, Mr. Morrison seemed to be saying, so be it.

In addition, not to be outdone by its predecessor, the current (102nd) Congress, driven by statistics that foreign multinationals are systematically stripping U.S. subsidiaries of taxable U.S. profits through improper transfer-pricing of "in-bound" intercompany transactions,(7) raised the rhetoric (and degree of departure from the arm's-length principle) to a new plateau. H.R. 5270 hence proposes that foreign-owned U.S. marketing and distribution subsidiaries report taxable profit derived from the sale of goods imported from foreign related persons of no less than 75 percent of a formulary-determined amount, irrespective of the actual business result experienced. The legislative drafters explained that this rule is intended to override treaty obligations:

It is believed that the Bill does not violate treaties.

. . . If, despite the belief expressed above, it is

ultimately determined that this provision of the

Bill violates a treaty obligation in the United States,

it is intended that the provisions of the Bill will

nevertheless apply.(8)

The aforementioned U.S. initiatives respecting the substantive law of transfer-pricing (commencing actually with earlier legislation in 1982 and 1984(9) were spawned ironically enough by two totally unrelated phenomena. First, starting in the 1970s, U.S.-based multinationals utilized Puerto Rico, and other jurisdictions to transfer U.S. parent company income offshore.(10) Second, starting in the early 1980s, concerns arose respecting (mainly Japanese-U.S.) in-bound transactions.(11) The substantive rules, of course, have been accompanied by not uncontroversial bookkeeping and reporting requirements particularly, again, aimed at in-bound transactions involving foreign-based multinationals under section 6038A, et seq. (as well as punitive transfer price penalties under section 6662).

As each development unfolded, the international business and tax community and foreign tax authorities reacted with a blend of harsh criticism and sighs of passive resignation. These, in general, have been blithely ignored or rejected by the U.S. tax authorities in their fervor to counter perceived abuses and revenue losses stemming from alleged improper transfer-pricing, without regard to the fundamental cracks wrought in the foundation of underlying tax rules for international transactions. It is not for nothing that an international tax journal recently noted that "transfer-pricing issues continue to be the hottest topic in international taxation these days, and the U.S. continues to be the country most responsible for fanning the flames".(12)

B. The Conundrum in Transfer Pricing

The purpose of this article is not particularly to dwell on either the substance of or concerns arising from the aforementioned U.S. initiatives. These initiatives are in some respects explained by the U.S. government's deep frustration of trying to make the traditional "arm's-length principle" work in a fashion that is equitable and fair for taxpayer and tax authorities alike. It is therefore useful to examine the reasons for the frustration. It arises out of three interrelated factors.

The first factor is that transfer-pricing law is, in the United States, Canada and most developed countries, quite simplistic and imprecise. Imbedded in the logic of the 1968 U.S. section 482 regulations (and propagated in a 1979 OECD report(13)), there is the priority principle that comparable unrelated party transactions (i.e., the comparable uncontrolled price (CUP)) provide the best and most objective standard to establish an intercompany price. Often, however, "comparables" are unavailable and the issue devolves into a case-by-case inquiry of facts and circumstances.(14) Unfortunately, in light of the many different facts and factors generally extant (and the subjective evaluations inherent therein), agreement between tax authorities and taxpayers is often difficult to reach.(15)

The inherent uncertainty often leads to debate whether mechanical-formulary methods should be substituted for the arm's-length principle. Leaving aside the current H.R. 5270 initiative such a roaches have been uniformly rejected at least in principle. Hence, in Canada, the United States, and most other developed countries where comparables are not available, the issue effectively becomes a facts-and-circumstances inquiry to evaluate the respective contributions made and risks undertaken by each unit in a multinational in respect of the overall profit of the group.

The second factor is the differing (and sometimes competing) taxpayer or tax authority objectives and priorities that are affected or effected by the manner in which transfer prices are set between the units of a multinational. First, there is the basic necessity of establishing transfer prices to determine each taxpayer's income, at least for tax purposes. Second, tax authorities are often concerned that transfer-pricing can be used to reduce taxation, either in the context of a tax-motivated structure(16) or simply, in the case of straightforward business dealing between units of multinationals, by improperly shifting income in such a way as to reduce overall group taxes. (17) Third, taxpayers and tax authorities are concerned that, even in the absence of tax motivation in establishing transfer-pricing, the inherent uncertainty in the process as well as the significant dollars that may be at stake (for either taxpayers or for competing fiscs) create a ubiquitous risk of costly and time-consuming disputes between the two sides.

The third factor is the concern of taxpayers, arising consequentially out of the preceding factors, of the ever-increasing burden associated with the rash of recently enacted rules (particularly in the United States) to ease the tax authorities' task of identifying and then auditing intercompany transactions.(18)

C. The Proposed Section 482 Regulations

Viewed from abroad, the proposed section 482 regulations that the IRS released on January 24 seem to raise more issues than they solve. To the extent viewed by tax authorities in other countries as conflicting with generally accepted norms of establishing arm's-length intercompany transfer prices, they increase the risk of double taxation.

For example, the exceedingly narrow view of CUPs taken by the Matching Transaction and Comparable Adjustable Transactions Methods is troublesome. It is perhaps the approach to "other" or "fourth" methods (the Comparable Profit Method), however, that will create the most difficulty in reconciling the U.S. proposals with the preexisting U.S. approach and that in other countries such as Canada.

Leaving aside the mind-numbing complexity in the language of the proposed regulations and the obvious substantial burden that will arise from applying the method, one element of its application marks a clear departure from any norms of arm's-length transfer-pricing. In particular, the profit comparison (i.e., the comparable profit interval) is to be determined by using a three-year period, one of which is the year following the year being tested (the others being the year being tested and the prior year). This means that taxpayers cannot use this method to establish a price for a transaction unless all norms of third-party dealings, including the fact that prices are normally set at the point of transaction, are aborted and, instead, the transactions and accounts of the parties are left open and undetermined until well after the transactions and well after the end of the particular tax year in which they take place.

In essence, the comparable price method may well serve as a valuable government audit technique, but it cannot be used by a taxpayer unless contracts between companies in a group specifically incorporate into their pricing method this ex-post-facto methodology and thus leave open the determinations to provide for adjustments based on the application of the method. In such circumstances, a number of problems will arise for members of the group based in countries such as Canada which require timely and current financial statements for tax return reporting purposes.

This new approach clearly appears to be deficient in not providing an overriding rule that a taxpayer is entitled to rely on its transfer prices to the extent it can show that the factors taken into account at the point of setting the prices were reasonable in light of the information reasonably available to the taxpayer at that time. To provide for adjustments based on factors occurring after that time or that would not be considered to be reasonably available to the taxpayer (such as the diverse amount of information required respecting unrelated companies) clearly constitutes a departure from the norms heretofore associated with applying the notion of arm's-length pricing.

Furthermore, any reading of the excruciatingly detailed procedures required to carry out the profit comparison (and construct the comparable profit interval) makes plain that there will be great subjectivity in determining the relevant profit level indicators and the constructive operating incomes. Consequently, there is little likelihood that any two or more persons, whether taxpayers, tax administrators, or courts, would agree on the determinations to be made by application of the method. Nothing in the proposed regulations eliminates the inherent and basic subjectivity that arises where objectively assessable comparables are not available.

While the proposed method provides a very useful framework in which a facts-and-circumstances inquiry is to be carried out (as an "other" or "fourth" method, where comparables are not available), it can at best reduce the degree of uncertainty of results, not eliminate it. Moreover, in its proposed form, the approach has significant ancillary negative characteristics or effects.

In summary, where business realities require determinations at the point of the transaction, the ex-post-facto nature of the interval method is troublesome and it would clearly be inappropriate to cast it as a rule of law providing for determinations that will actually govern taxpayer's affairs. Rather every attempt should be made to utilize the objectivity inherent in transactions that are similar in important respects, even if not identical. Furthermore, imperfect comparables should not be preempted by any subordinate method based on a laboratory-like comparison of the diverse activities of different companies (which appears appropriate in theory, but in reality is most likely incapable of producing objective determinations).

II. Is the Solution Advance Pricing Agreements?

A. Overview

It is ironic that, almost contemporaneously with the transfer-pricing controversies it has spawned, the United States has taken the initiative in developing and promoting an approach (perhaps the only approach) to resolving the seemingly intractable transfer-pricing issues that will otherwise arise. The procedure for securing an Advance Pricing Agreement, adopted through Rev. Proc. 91-22,(19) is intended to permit the parties to thrash matters out in advance and agree to specific transfer prices or ranges.(20) Although transfer price issues are often resolved by competent authority proceedings (e.g., pursuant to Articles IX and XXVI of the 1980 Canada-U.S. Income Tax Convention(21)), the delays and uncertainty inherent therein render an advance ruling procedure highly desirable.

Notwithstanding some reservations respecting the substantial detail (and attendant costs) apparently mandated by the U.S. rules for obtaining an APA, the IRS initiative has been met with enthusiasm by taxpayers and tax authorities in other countries. For example, prior to the IRS initiative, Revenue Canada had rejected requests for such rulings (on the basis that any unilateral ruling would hamper subsequent competent authority proceedings in the event of disagreements with tax authorities of the country involved).(22) Now, Revenue Canada is testing the procedure.

B. Current Status of U.S. APAs

As of July 1, 1992, at least six APAs had apparently been arrived at and many others (rumored to be in the area of 40) were under consideration by the IRS involving several countries, including Canada, Germany, and perhaps Japan and United Fingdom.(23) Indications are that the IRS is quite flexible and will modify the ruling process to accommodate the particular facts and circumstances of the taxpayer.

C. The Canadian Situation

1. Overview

Prior to the APA initiative by the United States, Revenue Canada had been reluctant (and, indeed, had refused) to issue rulings respecting intercompany transfer-pricing. Now, the government seems to endorse the purposes and approach of the United States and is actively pursuing the matter.

2. Basis for Transfer-pricing Rulings

a. Domestic -- Information Circular 70-6R2(24)

There are two different or alternative ways in which pricing rulings or agreements may develop in Canada -- one under domestic law and one under treaty. The former procedure is governed by a non-statutory, administrative ruling procedure (which is described in Information Circular 70-6R2 (Sept. 28, 1990)) and has generally worked well in the past and presumably can serve as the basis for transfer-pricing rulings. Under this approach, there presumably could be two-party agreements between Revenue Canada and a Canadian taxpayer or four-party agreements between Revenue Canada and a Canadian taxpayer and their counterparts in another country (e.g., the IRS and the U.S. member of a multinational group). The two-party approach (provided for in the United States by the APA procedure) would be particularly relevant where the related party involved in the transaction is resident in a country not having a treaty with Canada. Informal discussions with Revenue Canada suggest that any formal rulings procedure will provide for both types.(25)

Elements of Information Circular 70-6R2 that may be relevant to transfer-pricing rulings are, as follows:

1. Although advance rulings may be refused (paragraph 2 of the Circular), if they are issued they "will be regarded as binding upon the Department" (paragraph 4).

2. Although a ruling normally is limited to an interpretation of the law as it applies to a transaction, paragraph 7 contemplates rulings based on questions of fact "but only if it is possible to determine all the material facts and those facts can reasonably be expected to prevail." Paragraph 14(j), however, excludes a ruling where "a matter on which a determination is requested is primarily one of fact and the circumstances are such that all the pertinent facts cannot be established at the time of the request for the advance ruling." These positions concerning rulings on factual matters are sufficiently elastic to either grant or deny a ruling on transfer-pricing matters in any particular situation.

3. Rulings are given for a specific transaction that will be completed within a defined period of time.(26) Paragraph 10, however, contemplates a ruling covering "a continuing action or series of actions"; consequently, an intercompany pricing ruling would come within the parameters of the Canadian ruling process.

4. Rulings may be revoked where "there is a material omission or misrepresentation in the statement of relevant facts" (paragraph 9). In light of the inherently factual nature of pricing matters, this provision may be especially important.

5. Paragraph 17 notes that transactions ruled on "are subject to examination by the district taxation office during the course of any subsequent audit." Given the IRS's intention under the revenue procedure to coordinate audit under transfer-pricing agreements that have been entered into on a bilateral basis with other countries [as well as the preexisting simultaneous audit program between Canada and the United States (with respect to selected matters involving tax havens)], coordinated Canada-U.S. audits of transfer price agreements could well ensue.

In summary, the existing rulings procedures appear sufficiently broad in scope for Revenue Canada to adopt a policy of granting advance rulings for intercompany transactions. One practical difficulty is that rulings are administered by a unit of Revenue Canada distinct and separate from the Revenue Canada unit that is responsible for both international audits and treaty application (including competent authority) and it is the latter that is handling the two test rulings (as discussed below).

b. Treaty Basis

Canada's treaties, like most, generally provide a procedure for resolution of double taxation arising from intercompany disputes.(27) Although disputes between certain countries (e.g., Canada and the United States) are generally resolved, competent authority provisions do not generally require that the competent authorities arrive at a settlement eliminating double taxation but only that they make an effort to do so.(28) This makes it useful to consider a treaty-based four-party advance agreement procedure.

Without any specific or formal announcement or statement, Revenue Canada is testing the efficacy of transfer-pricing rulings, in one case involving a U.S. parent with a Canadian subsidiary and in another involving the converse case, a Canadian parent with a U.S. subsidiary.(29)

c. Summary

Canadian practitioners await the outcome of the two test cases with which Revenue Canada is now involved. Recent and informal discussions with Revenue Canada suggest that a decision should be taken by the fall of this year whether to adopt the full and formal ruling procedure.

D. Situation in Other Countries

1. Overview

The background issues and concerns discussed above clearly arise in other developed countries. This is so both with respect to (1) the relationships between law, tax authorities, and taxpayers, and (2) the effect of U.S. developments.(30) As in the case of Canada, the law' in such countries (except Japan) reflects the generally worded approach of the type found in subsection 69(2) and (3) of the Canadian Income Tax Act.(31)

Not surprisingly, then, the tax authorities in most other countries have greeted with much interest the U.S. transfer price ruling initiative. In the fall of 1990, following the issuance of the first draft of the IRS proposal, the tax authorities of Australia, Canada, Japan, and the United States (which make up the Pacific Association of Tax Administrators or PATA) met to discuss the project. Even before that time, Australia issued a August 24, 1990, press release entitled Taxpayers to Benefit From New Transfer-pricing Arrangements," which announced the adoption of a rulings procedure.

2. Australia

Australia's transfer-pricing law conforms with the pattern described above and, as previously noted, that county has already formally adopted an advance ruling procedure. The first ruling has already been issued, in conjunction with the United States, on a bilateral basis, with respect to the Apple Computer group. An agreement was made for a four-year period.(32)

3. France

The general pattern described above applies also in France. At this point, however, the French Government believes that its domestic law would preclude participation in advance pricing agreements.(33)

4. Germany

In Germany, which has issued elaborate administrative guidelines respecting transfer-pricing, advance rulings have been available since 1990. Detailed explanations of the economic basis, based on arm's-length considerations, are required, and the taxpayers involved must reduce their dealings into clear and unambiguous agreements. Rulings will be issued for the intercompany sale of goods, technology transfers, and cost-sharing arrangements.(34) Finally, the recently renegotiated treaty between Germany and the United States supplements the usual provisions for resolving transfer-pricing issues with a procedure for arbitration.

5. Italy

Although the legal basis for transfer price matters in Italy comports with general international principles, it is only recently that Italian tax authorities have focused on transfer-pricing matters:

The number of audits where the issue is raised is

still limited if compared to other countries. Tax

officials making the audits have the tendency to

carry out an extensive transfer-pricing examination

exclusively if, at the outset, the rate of return of the

investigated company is lower than the average

rate of return in the same business sector. The tax

officials realize that a transfer-pricing audit is costly,

time consuming and very risky because it may

end up with no adjustments (this would mean a

negative performance for the tax officials). Litigation

is almost non-existent.(35)

To date, no binding ruling practice has been developed in Italy, but one is now being carefully considered by the Italian authorities. At this point, however, the Italian Government believes that its domestic law would preclude participation in binding advance pricing agreements and administrative procedures cannot be relied on; consequently, legislation would be required to facilitate advance rulings.(36) Nevertheless, at least one non-binding agreement was reached in 1990. This agreement related to prices of printers manufactured in Italy by an Italian subsidiary (of a U.S.-based group) acting as a contract manufacturer.(37)

6. Japan

Japan has enacted detailed transfer-pricing rules, basically reflecting the U.S. and OECD approaches:

Most of the contents of the Japanese transfer-pricing

rules comply with the "Transfer-pricing and

Multinational Enterprises" report of the OECD

Committee on Fiscal Affairs, 1979.(38)

Although the matter is not yet settled, with respect to advance ruling procedure "... the Japanese government should not be negative because of the different nature of the provisions of the domestic law, but should actively cooperate with the APA (Advance Pricing Agreements) from the important standpoint of the elimination of double taxation for bona fide taxpayers with no intention of either avoiding tax or transferring income".(39) Furthermore, upon enacting its transfer price rules in 1986, Japan created a so-called pre-confirmation system. Under this system, there could be unilateral discussion with the Japanese tax authorities of transfer price determinations before the filing of tax returns.(40) The system, however, apparently is not popular because of administrative burdens placed on taxpayers and because of the difficulty of reaching agreement with the government.(41)

According to reports of remarks made by Haruhiko Kuroda, Director of the First Tax Division in the Japanese Ministry of Finance, "Japan's national tax administration has recently decided to participate in the advance ruling process on a pilot basis."(42) Mr. Kuroda has written:

Advance determination ruling (ADR) in the U.S.

may be one of the answers to international cooperation

among tax authorities, although its effectiveness

or practicality will be judged after operation

for a period of time.(43)

7. Netherlands

In the Netherlands, transfer-pricing law is not governed by any specific statutory provision, though the general concept of the arm's-length principle is firmly established in the law and applies to the business profits of corporations."(44) The adherence to the arm's-length principle and the 1979(45) and 1984(46) OECD studies was officially announced as being government policy.(47) There have been a number of court cases in the Netherlands. "Although many of these cases were of a rather factual nature, taxpayers can derive guidance from them on some aspects of the arm's-length principle."(48)

The Netherlands grants advance rulings in certain areas. "The most common tax rulings relate to financing activities (including allocation of financial profits to foreign branches), licensing activities and support activities of a preparatory or auxiliary nature."(49) Pursuant to a resolution of April 26, 1990, BNB 1990/1989:

The advance consideration by the tax administration,

within the scope of tax legislation, case law

and resolutions, of the total profit of an international

group with activities performed in the Netherlands.

In the ruling the tax administration shall

determine what may be taken to be an arm's length

remuneration regarding activities which are actually

being performed within the Netherlands between

related parties or....."(50)

Such rulings are generally given for three to four years and may be renewed for a further four-year period unless contrary to emerging law or policy.(51) Rulings have not generally been issued, however, for transfer-pricing for the sale of goods(52) and the Dutch government is reported to have not yet decided whether to endorse the general APA system of the type advocated by the United States.(53)

8. United Kingdom

The United Kingdom has specific statutes concerning transfer-pricing, principally in section 770 to section 773 ICTA 1988. These statutes provide for the implementation of the arm's-length principle that is in any event more generally a part of U.K. law. Moreover, the United Kingdom has had no transfer price litigation.

Discussions with officials of the Inland Revenue (International Division) confirm that concern exists that the underlying factual nature of the transfer-pricing makes it difficult to make advance binding determinations. In general, then, the Inland Revenue has reservations about the usefulness of advance agreements, mainly on practical grounds. Notwithstanding such reservations (and the absence under U.K law of any specific provision enabling the Inland Revenue to enter into binding advance rulings), the Inland Revenue adopts a flexible and pragmatic approach designed to reach settlements by negotiation. Accordingly, and in particular where transfer prices cannot easily be established under traditional arm's-length pricing methods, it may be possible under competent authority provisions to enter into agreements with the competent authorities of other countries concerned. Negotiations have recently been successfully completely on some test cases,(54) undertaken to determine whether such agreements can be reached. At present, a few other cases undertaken on an experimental basis have yet to be resolved.

The Inland Revenue is now reflecting on the experience and, though there may be other cases in the future, the Inland Revenue does not necessarily expect a large number. Moreover, as previously noted, the Inland Revenue does not currently have the legislative authority to adopt a general system of advance rulings for transfer-pricing matters.(55)

III. Notes Respecting Transfer Price Arbitration

A not totally unrelated development, arising contemporaneously with APA and other recent developments, is the question of settling transfer price disputes through binding arbitration. This is taking various forms.

First, there is the recently renegotiated treaty between Germany and the United States that, in addition to the usual provisions for resolving transfer-pricing issues, provides a supplemental procedure for arbitration. Article 25 states:

Such agreements between the contracting states

regarding the interpretation or application of this

Convention shall, as far as possible be settled by

the competent authority. If the dispute cannot be

resolved by competent, it may, if both competent

authorities agree, be submitted for arbitration. A

procedure shall be agreed upon, it shall be established

between the contracting states by note to be

exchanged through diplomatic channels.

Second, there is the European Community Convention on the elimination of double taxation, which establishes an arbitration procedure to resolve transfer-pricing issues. It is in a form of a multinational convention that will come into force after ratification by all member states. Binding arbitration would be arrived at only after failure of a typical competent authority procedure in respect of transfer-pricing disputes.(56)

Third, there is the U.S. Tax Court-sponsored arbitration process, which has been invoked in the Apple Computer "baseball" arbitration procedure, which is now underway. In June of 1991, it was reported that the Internal Revenue Service, Chief Counsel, Abraham M.N. Shashy, was seeking "to identify complex, fact-intensive foreign tax cases that may be suitable for resolution under a new voluntary binding arbitration rule of the U.S. court...."(57) According to the report, Mr. Shashy said that:

the Service is looking forward towards "non-judicial"

solutions to speed up and approve the resolution

of transfer-pricing disputes under Internal

Revenue Code Section 482. The rule 124 of the U.S.

Tax Court, which became effective July 1990, allows

the parties to resolve factual issues through a

voluntary binding arbitration. A single arbitrator

is appointed and then there is a binding and confidential


In the early spring of 1992, the IRS and Apple Computer agreed to Tax Court arbitration involving the baseball arbitration approach, whereby each side puts forward the transfer price to govern the matter with the Tax Court selecting one or the other.(59)

IV. Concluding Comments

In light of the many difficult and slippery issues that arise in dealing with the rather simplistic tax law respecting transfer-pricing, the advent of advance ruling procedures should prove to be overall beneficial to both taxpayers and tax authorities.

Assuming that Canada and other countries continue to eschew mechanical or formulary approaches to allocating income between units of a multinational and retain the facts and circumstances based "arm's-length" principle approach, there seems to be no reason why advance rulings will not take on an increasingly important role in dealing with the uncertainties, and ensuing issues, inherent in transfer-pricing based on the arm's-length principle. (**) Footnotes are printed on page 259.


(1) The super royalty provision was added by section 1231(e) of the Tax Reform Act, Public Law No 99-514 (Oct. 22, 1986) to the preexisting intercompany pricing rule under section 482. For a Canadian perspective, see Nathan Boidman, The Section 482 White Paper-A Canadian Perspective, 41 The Tax Executive 285 (Spring 1989). (2) "A Study of Intercompany Pricing, Prepared by Treasury Department's Office of International Tax Counsel and Office of Tax Analysis, and Internal Revenue Service's Office of Assistant Commissioner (International) and Office of Associate Chief Counsel (International), Discussion Draft Released Oct. 18, 1988" ("the White Paper"). (3) Internal Revenue Service Notice of Proposed Rulemaking (INTL-0372-88, INTL-0401-88), Intercompany Transfer Pricing and Cost Sharing Regulations Under Section 482 (Jan. 24, 1992), published in Federal Register on January 30, 1992. For a detailed study, see Robert T. Cole, Section 482: Proposed New Regulatory Approaches, 44 The Tax Executive 95 March-April 1992). (4) H.R. 5270, "Foreign Income Tax Rationalization and Simplification Act of 1992," introduced in the Committee on Ways and Means of the House of Representatives on May 27, 1992, would amend section 482 to, generally, require that a 25-percent or greater foreign-owned U.S. subsidiary report a minimum amount of income for U.S. tax purposes in respect of the sale of goods purchased from certain affiliated non-residents. (5) Internal Revenue Service Advance Revenue Procedures 91-22, 91-23 and 91-24 (relating to section 482 pricing), reprinted in 1991-11 I.R.B. (March 18, 1991). For a detailed discussion, see Michael F. Patton, Advance Pricing Agreements: Practical Issues to Consider in Determining Whether to Pursue One, 43 The Tax Executive 392 (November-December 1991). (6) Canadian Branch, International Fiscal Association, International Tax Seminar (Montreal, May 11, 1992). (7) U.S. observers frequently take issue with accuracy and relevancy of such data. See "Study Finds Similar Tax Rates Between U.S. and Foreign-Owned Firms," BNA Daily Tax Report, No. 71, at G-3 (April 13, 1992). (8) Staff of the Joint Committee on Taxation, Explanation of H.R 5270 (JCS-11-92), at 54 and 55 (May 29, 1992). (9) See I.R.C. [section] 367(d). (10) "See, e.g., Eli Lilly & Co. v. Commissioner, 856 R.2d 855 (7th Cir. 1988), and Bausch & Lomb, Inc. v. Commissioner, 92 T.C. No. 33 (1989), aff'd, (2d Cir. May 14, 1991) (No. 89-4156). (11) See, e.g., "Rep. Pickle, IRS Says Abuses in Transfer Pricing Results in Revenue Loss of Billions," BNA Daily Tax Report, No. 133, at G-4 (July 11, 1990). (12) John G. Goldsworth, Transfer Pricing: American Tax Institute Conference Focuses on Recent Transfer Pricing Developments, 3 Tax Notes International 828, at 828 (August 1991). The ATI Conference referred to was held in Paris on June 26-27, 1991, and featured representations by government representatives from seven countries. For the published papers, see The American Tax Institute in Europe, International Transfer Pricing: Current Developments (Conference Documentation, Tomes 1 and 2). (13) Organisation for Economic Co-Operation and Development, Transfer Pricing and Multinational Enterprises (Report of the OECD Committee on Fiscal Affairs 1979). (14) This pattern, for example, is seen in Canada where subsections 69(2) and (3) of the Canadian Income Tax Act require prices that "would have been reasonable had the parties been dealing at arm's length." The only elaboration on the statutory rule is set forth in a non-binding governmental information release, Information Circular 87-2, International Transfer Pricing and Other International Transactions (Feb. 27, 1987), which basically synthesizes and summarizes the 1979 OECD Report, which is itself based on the section 482 regulations, with the underlying principle reflected in just a handful of court decisions. See Nathan Boidman, Canada's Administrative Guidelines for International Transactions: Information Circular No. 87-2, 40 The Tax Executive 35 (Fall 1987). (15) These issues will be dealt with by the International Fiscal Association at its 1992 Congress to be held in Cancun, Mexico, in October, where one of the two major topics to be studied is "Transfer Pricing In The Absence of Comparable Market Prices." (16) With respect to Canada, see Nathan Boidman, The Canadian Approach to Offshore International Transactions: Indalex v. The Queen - A Transshipment Case, 39 The Tax Executive 45 (Fall 1986), and Nathan Boidman, The Canadian Approach to Offshore International Transactions: An Update, 40 The Tax Executive 383 (Spring 1988). (17) This may often turn on tax-rate arbitrage such as where overall U.S. corporate rates of tax for a U.S.-based multinational may be less than applicable Canadian corporate and withholding taxes applicable to distributed profits of a U.S.-owned Canadian subsidiary. This factor has often led Revenue Canada to concerns of overpricing by U.S. companies to their Canadian affiliates. Tax-rate arbitrage, however, does not seem to explain the U.S. concerns respecting overpricing by Japanese companies. (18) The United States has its section 6038A, et seq., rules. In Canada, the counterpart arises under section 233.1 of the Income Tax Act which, under the pain of substantial penalty, requires a filing of prescribed annual information reporting concerning intercompany transactions, on Form T106. In addition, there was a companion enactment (in 1988) of section 231.6 concerning access to foreign-based documents and the extension, pursuant to subsection 152(4), of the period for reassessing intercompany transactions from three years to six years in the case of Canadian-controlled private corporations and from four years to seven years in other cases. (19) Credit for developing the rulings approach for transfer pricing should be shared between Australian and U.S. tax authorities who (apparently) first discussed the matter at a meeting of the Pacific Association of Tax Administrators in Australia in the summer of 1989. (20) It is in some ways perverse to see the possible marriage of the two extremes in recent U.S. tax developments in H.R. 5270, where one of the few exceptions to the minimum income requirement will be a price determined in accordance with an APA. Section 304(a) of H.R. 5270 would add new sections 482(b)(2)(A) and (B) to the Code. (21) See Information Circular IC 71-17R3, Mutual Procedures--Requests for Competent Authority Consideration (Feb. 22, 1991.) (22) See Nathan Boidman, Revenue Canada's Transfer Pricing Circular: Selected Commentary, 36 Canadian Tax Journal 405, 411 (March-April 1988). (23) There are conflicting reports on the number of completed APAs. According to comments by Patrick Heck, Assistant Counsel of the House Ways and Means Oversight Subcommittee, there have been only three APAs signed (Apple Computer Inc., Sumitomo Bank Capital Markets Inc. and Barclays Bank PLC). See "U.S. Seen Abolishing Arm's Length Standard Unless Section 482 Enforcement Improves," BNA Daily Tax Report, No. 114, at G-1 (June 12, 1992). Others, however, have reported a greater number of APAs. See Apple Computer Executive Says Taxpayers Should Move Quickly on Negotiating APAs," BNA Daily Tax Report, No. 111, at p.G-7 (June 9, 1992) (quoting Philip J. Bergquist, Senior Tax Counsel for Apple Computer Inc., that "he had beard that an additional three banks have completed APAs," though they bad not been made public). (24) Information Circular No. 70-6R2, Advance Income Tax Rulings, (Sept. 28, 1990). (25) For a discussion on the U.S. position on two-party rulings (i.e., not involving other tax authorities), see "IRS Adds Tax Haven Jurisdiction To APA Cases, Says Ackerman," Tax Notes International Weekly (Dec. 23, 1991). (26) Paragraph 12 states that "[i]f transactions in respect of which an advance ruling was given have not been substantially completed within the time limit specified in the ruling, the ruling will not be binding upon the Department unless the taxpayer obtains confirmation that the ruling is still in effect. The Department may give such confirmation for further specific periods." (27) See, e.g., Article IX of the 1980 Convention. (28) A Canadian taxpayer would file a formal objection against a Revenue Canada assessment, thereby protecting its rights to litigate a matter should the competent authority procedure fail to provide relief. See Information Circular 71-17R, Requests for Competent Authority Consideration -- Double Taxation Issues. (29) Just before going to press it was confirmed that the two test cases have yet to be resolved. (30) See, e.g., Proposed Transfer Pricing Regulations Could Spark Tax War, Experts Say," BNA Daily Tax Report, No. 115, at G-1 (June 15, 1992), respecting a two-day conference on transfer pricing held in Paris by the American Tax Institute in Europe, on June 11 and 12, 1992. (31) For a survey of several countries, see Nathan Boidman, Canada-U.S. Intercompany (and Other) Taxation Issues, Report of Proceedings of the Canadian Tax Foundation's Thirty-Fifth Tax Conference 312 (1983). Although that commentary is now some eight years old, in many respects it continues to reflect the "state" of the law. (32) See "U.S., Australia Agree on Transfer Pricing Policy for Apple Computer," BNA Daily Tax Report, No. 64, at G-7 (April 3, 1991). (33) See "Advance Agreements, Competent Authority Said Best Remedies for Pricing Disputes," BNA Daily Tax Report, No. 125, at G-8 to G-9 (June 28, 1991) (statements by Vincent Mazauric of the French Ministry of Finance). Recent informal correspondence with the French Ministry confirms the existence of concerns at three levels: lack of legislative basis, difficulty of ruling on matters of fact, and insufficient audit resources. (34) See Alexander Vogele, Current Transfer Pricing Developments in Germany, ATI Conference, supra note 12 (unpublished paper). (35) Guglielmo Maisto, Intercompany Transfer Pricing (Italian Developments), ATI Conference, supra note 12 (unpublished paper). (36) See BNA Daily Tax Report, supra note 33 (statements by Mr. Franco Roccataglia of the Italian Ministry of Finance). (37) Ruling No. 9/281-90 (Sept. 29, 1990) (source: private correspondence with Guglielmo Maisto (June 16, 1992)). (38) Yugi Gomi, Current Transfer Pricing Developments - Legislative, Administrative and Judicial (Japan), ATI Conference Papers, supra note 12, Tome 1, at 146. (39) Id. (40) See id. at 152. (41) Yugi Gomi, Japan's Transfer Pricing Policies, ATI Conference Papers, supra note 12, Tome 2, at 166. (42) See BNA Daily Tax Report, supra note 33, at G-9. (43) Haruhiko Kuroda, A Few Observations of Transfer Pricing Taxation, ATI Conference Papers, supra note 12, Tome 1, at 353. Recent correspondence with the Ministry of Finance, Japan confirms little change since the date of the cited comments (in June 1991). (44) Waldo Kapoen, Transfer Pricing in the Netherlands: An Outline, ATI Conference Papers, supra note 12, Tome 1, at 154. (45) See supra note 13. (46) Organisation for Economic Co-Operation and Development, Transfer Pricing and Multinational Enterprises: Three Taxation Issues (Report of OECD Committee on Fiscal Affairs, 1984). (47) In answer to question of M.P. Vreugdenhil. Tweede Kamer 1988-89, 20, 365 NR.9 and NR.10. (Source: Private correspondence with Maarten Ellis (June 16, 1992).) (48) See supra note 44. (49) See supra note 44. (50) See supra note 44, at 158-59. (51) See supra note 44. (52) Advance rulings are sometimes provided in the case of a sale of goods where purchased for immediate resale and the function of the Dutch entity is limited to performing certain non-marketing tasks such as storage and delivery, financing, or administration. Source: Private correspondence from Maarten Ellis (June 16, 1992). (53) See BNA Daily Tax Report, supra note 33 (comments by a Dutch tax official). In a parliamentary discussion (Tweede Kamer, 1988-89, 20, 365 NR.10), the Dutch Ministry of Finance stated that it does not have the resources to develop and publish transfer-pricing guidelines for each sector of industry as some M.P.'s had suggested; it emphasized, however, its support for advance agreements on transfer-pricing issues with the Tax Inspector having jurisdiction. Source: Private correspondence from Maarten Ellis (June 16, 1992). (54) Two of these agreements, involving Barclays and Sumitomo, were announced by the taxpayers involved and entailed a treaty-based agreement where the U.S. unit of the group had entered into an APA with the IRS and then the IRS and the Inland Revenue under the authority of the U.K-U.S. competent authority procedure (to deal with difficulties in applying the treaty) came to an arrangement. See "Barclays Bank Becomes Third Taxpayer To Reach Transfer Pricing Accord with IRS," BNA Daily Tax Report, No. 89, at G-1 (May 7, 1992), "Sumitomo Bank Affiliate Sips Advance Pricing Agreement with IRS," BNA Daily Tax Report, No. 86, at G-1 (May 4, 1992). (55) See also BNA Daily Tax Report, supra note 33, respecting the U.K position. (56) See Jean-Pierre Hanin, E.C Tries To Unify Transfer Pricing, The International Tax Review 32 (May 1992). (57) See "IRS Chief Counsel Seeks Transfer Pricing Cases For Tax Court Arbitration Procedure," BNA Daily Tax Report, No. 116, at G-5 (June 17, 1991); "Arbitration Treaty Offers Solution To Transfer Pricing Disputes," Tax Notes International (May 1991); and Tax Court Judge Sees Need For Early Involvement In Transfer Pricing Litigation," BNA Daily Tax Report, No. 249, at G-1 (Dec. 27, 1991). (58) Id. See also "The IRS May Accept Dispute Resolution for Foreign-Source Income Cases, Nims Says," BNA Daily Tax Report, No. 215, at G-6 (Nov. 6,1991); "The Tax Court To Encourage the Use of Voluntary Binding Arbitration, Nims Says," BNA Daily Tax Report, No. 226, at G-4 (Nov. 22, 1991). (59) See "IRS and Apple Computer Agree To Tax Court Arbitration In Transfer Pricing Dispute," BNA Daily Tax Report, No. 45, at G-8 (March 6, 1992); "Service Issues News Release On Arbitration With Apple Computer," BNA Daily Tax Report, No. 46, at G-8 (March 9, 1992); "More On Apple's Arbitration Agreement," Tax Notes International (March 30,1992); "IRS and Apple Computer To Arbitrate Transfer Pricing Issue," Tax Notes International (March 9, 1992).

NATHAN BOIDMAN(*) is a partner in the Montreal firm of Goodman Freeman Phillips & Vineberg. He holds degrees in Civil Law and Common Law from McGill University, and is also a chartered accountant. Mr. Boidman practiced accounting from 1964 to 1973, and since 1974 has restricted his practice to consulting in tax matters. He has written numerous books and articles on international tax matters and lectures frequently on the topic. (*) The writer is grateful to Maarten J. Ellis (Loyens & Volkmaars, Rotterdam), Guglielmo Maisto (Maisto & Miscali, Milan), David Murby (Arthur Andersen, London), Jean-Pierre Le Gall (Jeantet & Associes, Paris), Alexandre Vogele (Price Waterhouse, Frankfurt), and spokesmen for the Ministry of Finance (Japan), Inland Revenue (U.K.), and the Ministry of Finance (France) for the valuable insights and information respecting the current status of transfer-pricing rulings in the countries discussed in section II.D.
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Title Annotation:Advance Pricing Agreement
Author:Boidman, Nathan
Publication:Tax Executive
Date:Jul 1, 1992
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