Release date: February 9, 2010
Guest: Susan Merlo
Running time: 10:14 minutes
Trying to manage the transfer pricing audit and assessment process can be strenuous. PwC's Susan Merlo shares insights and experiences relating to this growing concern.
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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 Susan Merlo, a senior manager with the transfer pricing practice in Toronto. Susan is a member of PwC’s Transfer Pricing Audit Controversy team and will share with us some of her thoughts and insights into the key pressure points in the transfer pricing audit process.
Thanks for joining us, Susan.
Susan: You are welcome, Sharon.
Sharon: Now, from your perspective Susan, what are the potential problem areas in the transfer pricing audit process that tax directors need to be aware of?
Susan: Well, when it comes to transfer pricing, unfortunately the audit process is like walking through a minefield. There are a lot of different considerations that a tax director would have to be aware of. For example, the audit process starts with the three-month letter for your contemporaneous documentation. Don’t leave that sitting on the corner of your desk. You are going to need help assembling that documentation if you don’t already have it, and it can’t be prepared within a week. So your first priority is to get that process going almost immediately.
The next point to remember when going through a transfer pricing audit is that you have to ensure you preserve your rights in respect to obtaining relief from any double taxation under Canada’s tax treaties. While under Canadian legislation, the CRA has seven years to conduct the audit; tax treaties may impose timeframes within which a reassessment must be made, in order for you to pursue double tax relief through the competent authority process.
The treaty roles under the Canada/US treaty are different than other treaties, in that the foreign competent authority has to be notified of a pending reassessment within six years from the fiscal year end if you hope to have the opportunity to obtain relief from double tax. So understanding and knowing your rights and the timing of the different treaties is critical in the initial stages of the audit process.
Sharon: What does a tax director need to know during the course of an audit Susan?
Susan: Sharon, develop a strategy at the start and stick to it. You will need to manage the auditor and not let the auditor manage you. It’s important to have a good rapport with the auditor, but the auditor is not necessarily your friend, and they will attempt to issue as high a reassessment as possible. You don’t want to agitate him or her—so cooperation and timely responses are important.
When issues arise during the audit, and you’re not making progress with the auditor, there is the ability to raise the issue to a higher level locally. There may be times, for instance, when an issue needs to be brought to the attention of the auditor’s case manager. Make a phone call or request a meeting if dialogue with a higher level at the CRA local office is needed to break an impasse.
The other thing to keep in mind during the course of an audit is that there are alternative remedies at the end of the day. You can file a notice of objection or, as previously mentioned, use the competent authority process. Of critical importance here is that when dealing with the auditor and the provision of information, you should already be planning on how the next level in the process will view the information or written response.
Sharon: So just to confirm, you are suggesting that a tax director should have a strategy in mind that includes the next level after the audit before they start dealing with the auditor?
Susan: Strategy is very important Sharon. It covers bases like laying out the ground rules on who the auditor can talk to and how requests for information are handled. Because transfer pricing is a gray area, any piece of information can be interpreted differently, so it’s important that when information is provided, an explanation should also be given so that the auditor will interpret the information the way you want him or her to see it. This is especially important when dealing with inexperienced transfer pricing auditors.
A lot of auditors really don’t understand how to make the connection between information they are reviewing and how your business operates. Unless this connection is continually made for them, you can end up with a reassessment proposal that doesn’t make sense to you but does to them, and then negotiations may be difficult.
This is why during the course of the audit, follow a strategy of trying to get the auditor to see what you want him or her to see and failing that, at least have the work done for the next level—whether appeals or competent authority.
Sharon: Now the tax director is through the audit process and the CRA has sent a letter informing him or her of a proposed adjustment that includes a potential transfer pricing penalty. What should the tax director now do?
Susan: Well the first step is to look at the amount of the adjustment to see whether it is high enough to warrant a penalty. At this point, the auditor will have to make a referral to the Transfer Pricing Review Committee in Ottawa. You are within your rights to see a copy of that referral, and you have the right to provide a rebuttal which will go to the Committee as well.
When you prepare your rebuttal, it should be prepared in a manner that strategically counters what the auditor may be alluding to in his or her referral. While you can continue to negotiate with the auditor, you have to be prepared that you may not get too far. Sometimes it’s best to let the auditor reassess and then take up the case to the next level.
You also have to consider your cash flow. Can you afford to pay the reassessment and potential assessment of Part 13 taxes? To avoid the payment of Part 13 tax, you will have the opportunity to repatriate the amount of the adjustment back into Canada.
However, to be allowed to do this, you have to waive your right to object to the reassessment. Unless there is no opportunity to obtain relief on the double tax through the competent authority process, waiving your right to appeal may not be an option. We often find tax directors are not comfortable with the competent authority process and prefer the traditional appeal process.
So when faced with the decision as to which way to go, keep in mind that unless you win the case outright in appeals, you will still be subject to some double taxation and will have to use the competent authority process at that point to obtain relief from double tax. So unless you are convinced that the reassessment will be overturned at appeals, it’s often preferable to immediately proceed to competent authority and save the time.
Sharon: Susan, what if the tax director is in a specific situation where he or she has been reassessed for a very large amount of tax? What are the options?
Susan: As noted earlier, when you are subject to double taxation, you can go through the competent authority process to have it relieved—provided Canada has a tax treaty with the other country which allows for such a process.
So when you do come across a situation where Canadian competent authority is not an option, the only avenue is to go through the appeal process.
Sharon: If the company is subject to double tax, does it have to pay the tax upfront?
Susan: Sharon, as a large corporation, you are required to pay fifty per cent of the federal tax, interest and penalties, and you can defer the other fifty per cent provided you file a notice of objection, even if you pursued the competent authority process. However, the interest clock will be ticking on the deferred portion.
As far as Part 13 tax and provincial tax goes, it has to be paid immediately. On occasion, you may be able to put up security against the amount owing on a provincial basis, and you can put up security for the fifty per cent that you are liable to pay on the federal portion— the interest clock does continue to tick.
Sharon: Ok now as a final question Susan, how do you suggest tax directors best use advisors like you in the transfer pricing dispute resolution process?
Susan: At the end of the day, we can manage the process on your behalf. The danger we see quite often Sharon, is that different people at the company talk to the auditor and will say something to him or her that may sound innocent, may be correct, but the interpretation of the auditor to that information and why he or she is really asking the question, that can come back and hurt you.
So what we like to advise clients is to let us manage the entire engagement from the start and let us be the front person dealing with the auditor. All questions are in writing, and all responses are prepared in a manner that will limit misinterpretation by the auditor. This way, we can guide you through the minefield and protect your interests as the audit proceeds.
Sharon: Thank you for your analysis and insights Susan.
Susan: Thank you, Sharon.
Sharon: If you are looking for additional information on transfer pricing, please go to our website www.pwc.com/ca/transferpricing, or contact your local PwC professional.
Thank you for tuning into Tax Tracks at www.pwc.com/ca/taxtracks.
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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.