Transfer Pricing Advance Pricing Arrangements (APAs) - an update

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Episode 12: Transfer Pricing Advance Pricing Arrangements (APAs) - an update

Release date: January, 19, 2010
Guest: Remi Gray
Running time: 10:59 minutes

PwC’s Remi Gray discusses the advantages of Advance Pricing Arrangements and shares key considerations for tax directors.

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Transfer Pricing Advance Pricing Arrangements (APAs) - an update

You're listening to another episode of PwC's Tax Tracks at www.pwc.com/ca/taxtracks. This series looks at the most pressing technical and management issues affecting today's busiest tax directors.

Sharon: Hi, I'm Sharon Mitchell and here with us today is Remi Gray, an Associate Partner in the Transfer Pricing team located in Ottawa. Prior to joining public practice, Remi worked for 25 years with the CRA, spending 18 of those years in the transfer pricing arena of which the last 10 years were as a Manager in the Competent Authority Service Division. Remi was directly involved in the negotiation of 39 APAs and resolved over 160 double tax cases. Remi will share with us some of his thoughts and insights on the advance pricing arrangement program.

Thanks for joining us, Remi.

Remi: Thank you, Sharon

Sharon: Now to start off, we are dealing with an environment of unprecedented CRA aggressiveness on transfer pricing audits. Tax directors want to know what tools are available to them to deal with the CRA over the longer term. What exactly is an advance pricing arrangement or an APA?

Remi: Well, an APA is a prospective agreement between a taxpayer and a tax administration (i.e., the CRA) in respect of your intercompany transactions. This agreement stipulates the transfer pricing methodologies to be applied to specific covered transactions. These agreements can either be bilateral where the CRA will negotiate with a foreign tax administration or unilateral, which is strictly between you and the CRA. Normally, an APA runs for five years but depending on the timeline elapsed during the negotiation process, you can request to extend for additional years.

Sharon: So Remi, why would a tax director go through the trouble of getting an APA in the first place and how is it going to help them?

Remi: There are numerous benefits to an APA. Some of the major ones are that they will give a tax director "tax certainty" in respect to their transfer pricing and take away any risk of the CRA conducting an audit. The CRA will be restricted to only verifying that the terms of the APA have been followed. This is especially important if historically, the tax director had audits that hadn’t gone well and seem to take forever. In addition, they would not have to worry about having contemporaneous documentation prepared for the transactions covered by an APA. Another benefit is the penalty protection. By adhering to the criteria of the agreement, no penalty will be applicable on the covered transactions.

Finally, the tax director will save on internal resources and fees when they consider the amount of time spent annually dealing with an audit and applying for relief of the double tax after the audit.

Sharon: So when would a tax director know that he or she should be considering an APA? What are some of the indicators?

Remi: It all goes back to whether or not they are going through a bad audit. Do they feel they have risk in respect to their overall transfer pricing policy? Tax directors are very aware these days of having a clean balance sheet, and they don’t want to expose the company to risk. If that risk is there, one way to relieve it is through an APA. Again, it goes back to the audit history. If the tax director hasn’t prepared any documentation to support their transfer pricing policies, an auditor may come in resulting in the issuance of a potential re-assessment.

Penalties are quite harsh in Canada. In fact, Canada has one of the harshest tax regimes for transfer pricing globally.

Sharon: Now if a tax director had a troubled relationship with the CRA in the past, would going for an APA help this relationship? Would it make the tax director’s relationship with the CRA better or, alternatively, more difficult?

Remi: In all likelihood, it is going to make your relationship with the CRA better. The APA program is non-adversarial and managed out of Ottawa by individuals who get out and promote the program within the tax community. It is a respected program under the tax treaties, and therefore they have to make the program work.

Keep in mind, at the audit level a more aggressive approach is often taken because the taxpayer can always fall back on appeals or competent authority to reverse a portion or all of the auditor’s adjustments. The APA team is more experienced, more practical and they are used to negotiating these types of agreements with their treaty partners and therefore have a less adversarial approach than auditors.

Sharon: So Remi, you are saying CRA is basically motivated to promote APAs. Will a CRA auditor cooperate?

Remi: Absolutely! And in my experience I haven’t seen any case where the local auditor has not cooperated. After all, the local auditor is very curious and looks forward to being a member of the APA team.

Sharon: Now, would a tax director deal with an auditor negotiating an APA or would he or she be dealing with different people in the CRA?

Remi: Actually, a tax director won't be doing any negotiations as part of the APA process. In a bilateral APA, the negotiations are strictly between the Canadian and foreign tax authority. Even the local CRA auditor is not permitted to participate in the negotiation process. And in a unilateral APA, there is no negotiation but a discussion relating to the functions, assets and risk identified, ensuring that all parties are clear of the facts. Once that happens, the CRA recommends an appropriate solution to the tax director for his consideration.

Sharon: If a tax director is already under audit with the CRA, do you think he or she could somehow get the APA process to address past years as well?

Remi: As part of the bilateral APA process, in addition to prospective years being covered, the program will allow the results to be applied to prior years (this is referred as the roll back years). There are some conditions around what could be considered as a rollback year, such as an audit has not been started and the foreign tax administration has to agree to cover these years as well.

It should be noted, however, that many auditors have been agreeable in stopping their current audit activity in order to allow an APA to take its course. Consequently, they will take the results and just apply them when the APA has been completed.

Sharon: So let me get this straight Remi, a tax director can bring any open audit year in under the APA and with an agreeable auditor may be able to bring a current audit year under an APA as well?

Remi: No. The year under audit is not covered under the APA program but the CRA auditor may agree to apply the results from the APA to the year under audit. Some agreements have been reached where the auditors will keep the audit years in abeyance while the APA is being negotiated. Once a settlement is reached, the CRA auditor can then apply the APA results to the audit years. Once these audit years has been reassessed, then the tax director can request relief from double taxation with the foreign tax administration providing relief in the elimination of double tax.

Sharon: If a tax director gets an APA, how can they leverage that APA on a global basis—in other words with other countries or with other arrangements?

Remi: It is rather difficult to do that because every country believes in its own sovereign right to dictate its own taxation terms. So the results of an APA between Canada and the US would not apply to an APA between Canada and, for example, Japan. However, a lot of the work that would have been done in the first APA can be leveraged into the second one – even though it is going to be a separate APA. And you may not get the same results even though the situations could be quite similar.

Sharon: So let’s look at APAs more critically then. It is generally known that some tax directors have had problems with the APA process, more specifically with the very long timeline with mounting costs. What can you tell us about these issues?

Remi: The CRA has an objective that it would like to complete an APA within two years from the date it receives the submission. What happens most of the time is that after a submission is made, you go through a site visit where the CRA will come in to verify the facts presented in the submission and then come back with additional questions. The sooner you respond to those questions, the better the process keeps going. My experience has been that companies can cause the delay because of resource issues or timing issues which can lead to delays that can run three to six months.

So if a tax director is willing to respond to these queries as soon as possible, those time delays responding to questions will be significantly reduced, so that the process can be ended sooner rather than later.

Sharon: Typically what would an APA cost a tax director? I guess it depends on the timeline involved.

Remi: The initial cost of an APA may be considered high. Naturally, this submission is going to be more detailed than your normal annual transfer pricing documentation, but there are other steps through the process such as attending a pre-filing meeting with the CRA in Ottawa and possibly a pre-filing meeting with the IRS in the US. But at the end of the day, it would be less expensive when you consider the cost of an annual audit defense, both for advisors’ and the tax directors’ internal resources, the cost of preparing annual documentation and the cost of going through the competent authority process—and once the APA is completed, then the worries are over for the duration of the APA.

Sharon: Thank you, Remi.

If you are looking for additional information on APAs or transfer pricing in general, please go to our website, www.pwc.com/ca/transferpricing, or contact your PwC professional.

Thank you for tuning into Tax Tracks at www.pwc.com/ca/taxtracks.

The information in this podcast is provided with the understanding that the authors and publishers are not herein engaged in rendering legal, accounting, tax or other professional advice or services. The audience should discuss with professional advisors how the information may apply to their specific situation.

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Through interviews with prominent PwC tax subject matter professionals, Tax Tracks is an audio podcast series that is designed to bring succinct commentary on tax technical, policy and administrative issues that provides busy tax directors information they require.