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December 1, 2010 No. 2010-38
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Resolving Canada-U.S. Double Tax Disputes through Arbitration – New Guidance
The Canada Revenue Agency (CRA) and Internal Revenue Service (IRS) recently released details on the new procedure to be followed by the Canadian and U.S. competent authorities for cases proceeding to arbitration under the Canada-U.S. tax treaty. The first wave of double taxation cases that have recourse under the procedure will become eligible for it on December 15, 2010. The newly issued details, released in the form of a memorandum of understanding (MOU) and a set of operating guidelines, offer the first comprehensive guidance to taxpayers on how the procedure will be implemented.
Background In situations of potential double taxation between Canada and the United States, the Canada-U.S. tax treaty’s mutual agreement procedure provides that the competent authorities of the two countries will generally act to resolve the case. The September 2007 protocol to the Canada-U.S. treaty added a new level of dispute resolution. Where the competent authorities cannot reach an agreement and the case has been unresolved for two years or more, mandatory arbitration should occur where certain conditions are met (see Article XXVI(6) – (7)).
Although the mandatory arbitration provision took effect on December 15, 2008, it only applies to cases that have gone on for two years or more. Thus, mandatory arbitration will be an option for unresolved cases for the first time as of December 15, 2010. For more background on the new procedure, including eligibility requirements, see TaxNewsFlash-Canada 2010-32, dated October 5, 2010.
Double tax cases eligible for arbitration
Accelerated competent authority procedure cases
Taxation years for which the accelerated competent authority procedure (ACAP) has been requested are eligible for arbitration at the same time as the earlier taxation years for which the related mutual agreement procedure (MAP) request was made.
Background Through ACAP, taxpayers can request assistance for subsequent taxation years on the same issue (in other words, for tax years after those giving rise to the competent authority request and for which tax returns have been filed, a taxpayer can request that the competent authority agreement be “rolled forward" as long as the underlying facts and circumstances are not materially different).
Advance Pricing Arrangements (APA)
As announced at the American Bar Association meeting in Toronto in September 2010 (see TaxNewsFlash-Canada 2010-32), bilateral advance pricing arrangements are also eligible for arbitration.
For APA taxation years for which tax returns will have been filed in both countries for at least 12 months (including rollback years) before arbitration begins, the arbitration board’s determination will simply be an amount of income, expense or tax reportable to Canada or the United States.
For APA taxation years for which tax returns have not been filed for at least 12 months in both countries, the transfer pricing methodology for the APA will be the one described in the proposed resolution selected by the arbitration board.
Cases ineligible for arbitration
The MOU provides a list of cases that the competent authorities will not consider for arbitration. This list includes cases where:
· The taxpayer has not otherwise complied with domestic requirements for MAP (i.e., as set out in the current versions of Information Circulars 71-17 and 94-4 in Canada and Revenue Procedures 2006-54 and 2006-9 in the United States) · A Canadian or U.S court has rendered a decision in respect of the same taxpayer, same issue and same taxation years · The taxpayer has agreed with the Appeals section of the relevant tax authority, or with Chief Counsel in the United States, to a settlement or closing agreement for the case · Both competent authorities have agreed that the case is not suitable for arbitration before the arbitration starts · Court proceedings have commenced in either Canada or the United States · The six-year notification under Article IX(3)(b) was not provided.
Unilateral rejection not permitted
Another helpful enhancement to the MAP process introduced by the MOU is that, once a MAP request is accepted, “neither competent authority will cease unilaterally to consider a case”, unless the case is otherwise ineligible for arbitration under the MOU.
Commencement date for arbitration wait period
For non-APA MAP cases, the two-year timeframe starts with the commencement date and (unless the two competent authorities agree on another date) ends two years later with the start of arbitration. The commencement date for non-APA cases is defined as “the earliest date on which the information necessary to undertake substantive consideration for a mutual agreement has been received by both competent authorities” (see Article XXVI(7)(b)).
In contrast, for APA MAP cases, the commencement date is the earlier of:
· the date on which the competent authorities have exchanged position papers, or · “two years from the earliest date on which the information necessary to undertake substantive consideration for a mutual agreement has been received by both competent authorities.”
The MOU confirms that the two competent authorities (but not the taxpayer) can consent to accelerate or delay the start of arbitration before the two-year mark following the commencement date. In these cases, the two competent authorities will notify the taxpayer.
KPMG observation Instead of maintaining the commencement date used for non-APA MAP cases, the MOU changes the definition of commencement date for APA MAP cases by delaying it by one to two years from the date of receipt of the information needed to consider the case. Thus, the MOU effectively inserts a one to two-year delay from the date of the necessary information’s receipt to undertake substantive consideration of the case so that arbitration only starts after another two years after that commencement date, resulting in a potential four-year timeframe.
Confirmation of commencement date
The MOU suggests that the competent authorities should either confirm whether they believe they have received enough information to consider a MAP request (and thus confirm the commencement date) or inform a taxpayer that the MAP request is incomplete within the following timeframes:
· For regular MAP cases, within 30 days after receipt of the information for confirmation or within 45 days for notification of an incomplete submission. · For APA cases, within 60 days after receipt of the information for confirmation or within 75 days for notification of an incomplete submission.
However, the MOU does not present these timeframes as mandatory.
Arbitration board members’ eligibility
The MOU states that potential arbitrators will have significant international tax experience but that current Canadian or U.S. government employees (and former employees for up to one year after terminating employment) are not eligible as arbitrators. The MOU provides for substitution of arbitrators during the mandate of the board.
The operating guidelines indicate that, within 10 calendar days of the appointment of the second board member, the board members must contact each other to discuss the appointment of the chair. The two competent authorities will agree to a list of “at least 10 qualified persons who are willing to serve as a chair for a board”. The list will be reviewed and revised annually. The two initial board members may select a chair who is not named on the list, as long as they inform the two competent authorities in writing.
Arbitration board procedures
The operating guidelines indicate that an arbitration board may adopt any additional procedures necessary for the conduct of its business (as long as they are consistent with Article XXVI). The chair must provide the two competent authorities with a written copy of any such additional procedures.
Proposed resolution and position papers
The MOU specifies that the proposed resolution paper for each issue in a given case should not exceed five pages. The supporting position paper cannot exceed 30 pages. Annexes do not count toward the 30-page maximum, but acceptable annexes only include:
· documents previously provided by one competent authority to the other, and · documents previously provided to both competent authorities by the taxpayers or their representatives for use in negotiating the case.
KPMG observation Due to this restriction on introducing new documents during arbitration, when a MAP case is nearing its commencement date, the taxpayer and his or her advisors should consider filing any such pertinent documents with both competent authorities, with recommendations for the arbitration board.
The MOU also specifies that the reply submissions of each competent authority cannot exceed 10 pages.
Failure to file proposed resolution
If one competent authority has filed its proposed resolution paper within 60 days but the other does not, then the submitted proposed resolution will be deemed to be the determination of the board and the chair will advise the competent authorities of this determination on the 61st calendar day after his or her appointment.
KPMG observation The MOU and operating guidelines do not specify what happens if both competent authorities fail to provide a proposed resolution paper within 60 days.
Communication with the arbitration board
The arbitration rules state that the competent authorities must not communicate with the board other than as specified in the MOU (i.e., in providing the proposed resolution and reply submission) unless the board requests additional information. Such additional information can only be requested from the competent authorities, and it must consist of existing documents. The board may not request new or additional analyses. The board must make the request to both competent authorities and specify a response deadline.
Specific rules for permanent establishment cases
The MOU and the operating guidelines provide slightly different rules for permanent establishment cases, including:
· a requirement to present the proposed resolution and position paper in a sealed envelope · a mechanism to terminate the case if the board determines that there is no permanent establishment, and · different forms of resolution.
Timeframe to render arbitration decision
The MOU says that arbitrators will be paid for no more than three days of preparation and two days of meetings, plus travel days. The operating guidelines severely restrict the use of staff and specify that they will not be remunerated by the competent authorities. Thus, each case should take no more than five working days to resolve once the arbitration board has all the relevant documents.
Taxpayer’s rejection of board’s determination
If a taxpayer either fails to accept the arbitration board’s decision within 30 days of its receipt or decides to withdraw its MAP request, MAP will not be available for the same matter and same years.
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