Memorandum of Understanding (MOU) on the Canada-U.S. Tax Treaty Arbitration Process

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Episode 32: Memorandum of Understanding (MOU) on the Canada-U.S. Tax Treaty Arbitration Process

Release date: March 16, 2011
Guest: Ivan Williams
Running time: 08:49 minutes

When Canadian companies have transactions with related parties in the United States, double taxation can be a concern. A key part of the process for resolving disputes in this regard is the Arbitration Process associated with the Canada-U.S. Tax Treaty. The Memorandum of Understanding (MOU) on that process is important because it ensures that these disputes will be resolved, and because arbitration encourages governments to resolve issues more quickly.

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Memorandum of Understanding (MOU) on the Canada-US Tax Treaty Arbitration Process

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: Today I’m speaking with Ivan Williams, the PwC Calgary Transfer Pricing leader. Ivan has also worked in PwC offices in Toronto and Vancouver as well as 7 years with PwC in New Zealand.

Thank you for joining us today Ivan.

Ivan: You’re welcome Sharon.

Sharon: So, Ivan — I understand that an important Memorandum of Understanding (MOU) on binding arbitration proceedings exists between Canada and the United States.

Maybe a little refresher on how this came about would be helpful.

Ivan: Well, the Canada – U.S. tax treaty provides for the two countries to negotiate resolution to issues that give rise to double taxation between related parties transacting across the border.

Over the years, issues came up that the two sides couldn’t agree on and the resolution of double taxation was becoming more and more difficult and taking longer. The 5th protocol to the treaty that was ratified on December 15, 2008 provided for binding arbitration in cases the two governments couldn’t agree on.

Generally, any taxpayer that has made a request for competent authority assistance under the treaty can proceed to arbitration after two years. However, this depends on whether the case is classified as one that is “eligible” to proceed.

Sharon: Who should be interested, and why is this important?

Ivan: Interested parties would be all Canadian companies that have transactions with related parties in the United States. This includes companies that have been audited and are currently in competent authority to obtain relief from double taxation those that are seeking certainty in their transfer pricing through a bilateral Advance Pricing Arrangement and companies that may someday be subject to a CRA audit.

The MOU is important for a couple of reasons. First, it provides a process under which taxpayers will be assured that double taxation will be resolved regardless of the positions of the two tax authorities, and second, the entire concept of arbitration will provide an incentive to the governments to resolve issues quicker as both sides have indicated that any cases proceeding to arbitration will reflect a failure in the system.

Sharon: I think I heard you refer to “eligible cases.”

Ivan: That’s right. The Memorandum of Understanding confirms that cases technically become eligible for arbitration if the competent authorities are unable to reach an agreement after two years.

This includes transfer pricing cases, cases where taxpayers have requested the Accelerated Competent Authority Procedure for subsequent taxation years, bilateral Advance Pricing Arrangements as well as residency and permanent establishment issues.

Sharon: Can you point to the type of cases that would not be eligible for arbitration?

Ivan: Sure. First, if the taxpayer has not provided all the information as required to the competent authorities, arbitration will be delayed.

Second, if the issue pertains to a situation that either has been handled by the courts or the taxpayer has agreed to an appeals settlement, it will not be considered for arbitration. A third relates to an existing situation under the treaty whereby the competent authorities have to be notified in writing of a pending request for assistance within 6 years from the end of the affected taxation year. If this is not done, the competent authorities will not accept that year for arbitration.

Sharon: The Memorandum of Understanding refers to a “commencement date.” What is the relevance of that?

Ivan: The MOU requires that the tax authorities advise the taxpayers in writing when the two-year clock starts ticking before the taxpayer can proceed with the arbitration process. As previously mentioned, this is generally when all the information has been provided to the competent authorities.

This is retroactive to when the protocol was ratified in 2008.

Sharon: One thing I’m not clear about is whether going to arbitration is desirable.

Ivan: Well, like other conflict situations, that depends on the circumstances. But it’s worth noting that both former competent authorities have publicly acknowledged that any case that proceeds to arbitration will represent a failure of the mutual agreement procedure. So, both countries can be expected to work hard to resolve any case that might appear to be headed for arbitration. In the end, it can only be beneficial to taxpayers.

Sharon: Ivan, how does the arbitration process work?

Ivan: Well, the first step is that the taxpayer and its representatives in each country must file nondisclosure agreements once the commencement date of the taxpayer has exceeded two years. This will get the process moving. If these agreements are not filed, then the process will not commence.

It is important to recognize that the Memorandum of Understanding is very time-restricted. Each phase has to be completed within a certain number of days — including the selection of the arbitration board.

In the case of bilateral Advance Pricing Arrangements, the time lines are somewhat extended due to the difference between an APA and a request for relief from double taxation that has resulted from an audit.

Once the nondisclosure agreements are filed, both competent authorities have to submit a proposed resolution along with a position paper to the arbitration board. Both of which are restricted by length.

The resolutions must describe how each specific monetary amount at issue in the case would be dealt with. For issues involving the existence of a permanent establishment or residency, they have to propose a "yes/no" result.

The competent authorities may submit reply submissions of up to ten pages in response to the information provided by the other competent authority.

Sharon: So a decision is made based on the written materials?

Ivan: Correct. And the arbitration board’s decision — made by majority vote — is binding on both competent authorities and will constitute a resolution by mutual agreement under the treaty.

If taxpayers in both countries do not accept the decision within 30 days, the determination is rejected and the taxpayers will not be subject to any further consideration for the years at issue.

Sharon: Is arbitration expensive?

Ivan: The two governments will share the fees and expenses of the arbitration proceeding itself. Therefore is no additional cost to taxpayers.

Sharon: Now, we’ve talked about a number of important specifics, but before we wrap up, do you have any broad observations to share on how this MOU will change things?

Ivan: I think it will and has create added pressure to resolve cases with difficult issues before they are eligible to proceed to arbitration. It will hopefully force the two sides to present more moderate positions earlier in the process rather than just digging in their heels.

Also, since arbitration cases are not precedent-setting, there will be a winner and a loser in these cases and we cannot foresee at this point how the field will react to the decisions. Will they continue to reassess taxpayers in the same manner? Who knows?

Sharon: Thank you, Ivan.

We’ve been talking to Ivan Williams, about a Memorandum of Understanding (MOU) between Canada and the United States with regards to mandatory binding arbitration proceedings under our tax treaty.

For additional transfer pricing information, please visit www.pwc.com/ca/transferpricing.

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.