A Look at Advanced Pricing Agreements in Canada: Lessons for India July 2012

1. A Look at Advanced Pricing Agreements in Canada: Lessons for India July 2012

2. Outline • About Dale Hill • Importance of APA Program in India • Transfer Pricing Defined • Advanced Pricing Agreements • Benefits and Procedures • Types of APAs and kind of transactions / industries generally covered • Trends in the Canadian APA Program • Conclusions

3. About Dale Hill • Partner, Tax Services • Gowling Lafleur Henderson LLP

4. About Dale Hill • Dale Hill is a partner in Gowlings' Ottawa office and is the national leader of the Gowlings Transfer Pricing and Competent Authority team. • Dale works in conjunction with the Firm's National Tax Practice Group to help organizations optimize their global tax position and reduce exposure to unfavourable audit assessments through proper tax planning and implementation strategies. • Prior to joining Gowlings in 2005, Dale was involved in international transfer pricing with the Canada Revenue Agency ("CRA") for 16 years.

5. About Dale Hill (cont’d) • During his tenure as a senior manager with the CRA's International Tax Directorate, he participated in more than 40 Advanced Pricing Agreements ("APAs") with numerous countries, as well as hundreds of Competent Authority requests relating to international transfer pricing adjustments involving a vast array of issues.

6. About Dale Hill (cont’d) • He is also experienced in a number of other international tax areas, including interest deductibility, guarantee fees, imputed interest, notional expenses, tax avoidance, ACAP, penalties and appeals. • Dale has been successful in resolving a number of controversial audit issues through successful negotiations with various tax authorities in a number of countries around the world.

7. Why is an APA Program Important for India? • India is a large and fast growing economy with significant potential. • For growth to continue, it will need significant levels of foreign direct investment. • While many factors determine the level of such investment, the taxation regime and its perceived transparency play a significant role for multinationals when considering resource allocation.

8. Why is an APA Program Important for India? • The Indian tax authority has a reputation for having aggressive auditors with inconsistent positions across various offices, just like Canada was. • While attempts have been made to remedy this problem, no significant headway has been made. • Implementation of safe harbour rules (suggested in Finance Speech in 2010) and the introduction of a dispute resolution panel failed to achieve tax certainty for taxpayers • Safe harbour rules were never announced by the government • Dispute resolution panel, which was supposed to make up for the lack of attribution and settlement mechanism in India failed to resolve contention cases

9. Why is an APA Program Important for India? • India would therefore benefit tremendously from an APA program. • Solving advanced tax problems in a more cooperative, less adversarial and more efficient manner is advantageous to all involved. • Looking at countries such as Canada, where the APA program has worked relatively well, may be advantageous for India.

10. Why is an APA Program Important for India? • Countries around the world, including Canada, have instituted APA programs to improve compliance • and to best deploy their transfer pricing • resources within the economy. • Taxpayers appreciate the certainty they provide. • This presentation outlines the APA program in Canada and suggests it serve as a model for India to develop their own.

11. Transfer Pricing Defined • Transfer Pricing is: • The price at which goods, services and intangibles are traded between non-arm’s length parties within a corporate group.

12. When Transfer Pricing Issues Arise • Transfer Pricing Issues Arise: • Whenever goods, services (e.g. marketing, accounting) or intangibles (e.g. patent or trade mark rights) are transferred between related parties across international borders (and in some cases provincial).

13. Importance of Transfer Pricing • Since a change in transfer prices can result in a change in profits reported in a particular tax jurisdiction, tax authorities around the world have made transfer pricing a priority.

14. Competent Authority Services Division Legal Services Director, Francis Ruggiero Advisors Competent Authority Competent Authority Treaty Specialist- Tam Nguyen Services Unit #1 A/Manager, Sudha Dukkipati Competent Authority Exchange of Information and Services Unit #2 Simultaneous Audit Manager, Manon Helie Manager - Dan Quinn Competent Authority Competent Authority Services Unit #3 Manager, Brian Busby Competent Authority Services Unit #4 Manager Services Economic Group A/ Chief Economist – Chris Lukie Canadian Competent Authority • Organization Chart • Competent Authority Services Division (CASD)

15. Advance Pricing Agreements (APAs) • A Closer look at Canada

16. Advance Pricing Arrangements (APAs) • An APA is a formal arrangement between the Minister of National Revenue and a Canadian taxpayer involved in cross-border transactions with a foreign related entity. • Bilateral APA (BAPA) or Multilateral APA (MAPA) is a formal arrangement entered into between the Canadian CA and its foreign counterpart under the MAP.

17. APA Program: What is it? • An arrangement between a taxpayer and a tax administration to confirm the appropriate transfer pricing methodology (“TPM”) for non-arm’s length transactions. • December 1994 – Information Circular 94-4 International Transfer Pricing – Advance Pricing Agreements • TPM establishes an arm’s length price for transactions between related parties. • Intercompany prices are based on the Arm’s Length Principle.

18. The Parties Involved • Competent Authority Services Division (CASD) within the International and Large Business Directorate of the CRA has responsibility for the APA Program; • Director of the CASD; • Auditors in MAP/APA units; • Economists in Economic Services unit; and • Typical APA team: lead analyst and an economist from the CASD and an auditor from the taxation services office (TSO).

19. Benefits of an APA • Prospective avoidance of double taxation • Penalty protection • Efficient resolution of recurring complex transfer pricing issues (less t/p time and audit resources) • Potential application of findings to past years • Long-term savings: renewals are usually less time consuming • Greater tax certainty

20. Procedures for Obtaining an APA • Prefiling meetings • Formal acceptance letter and user charges • APA submission • Review and evaluation phase • Finalization phase including negotiations • Compliance phase • APA renewal

21. How Do the Parties Achieve an APA? • The taxpayer indicates interest to CRA’s APA Coordinator (or local Taxation Services Office) on an informal or anonymous basis. • Prefiling meeting between CRA and taxpayer. • CRA and taxpayer commit to process: CRA issues conditional acceptance, taxpayer files formal APA request. Taxpayer also pays cost recovery amount (based on anticipated CRA travel costs).

22. Achieving an APA (cont’d) • CRA reviews APA request, issues official acceptance letter or seeks additional information if necessary. • CRA performs due diligence. • CRA sends draft position paper to taxpayer for a review of factual accuracy. • CRA sends a final position paper to the foreign tax authority and resolves the APA through competent authority negotiations (only for bilateral APAs).

23. Achieving an APA (cont’d) • CRA and Foreign Tax Authority negotiate the terms of an APA. The Tax authorities may ask the taxpayer for additional information. • CRA sends proposed APA to taxpayer for review, comments and acceptance. • If accepted, CRA sends final APA to taxpayer for signature and refunds excess cost recovery amount. • Taxpayer files periodic compliance reports and may request a renewal of the APA at the end of the APA term.

24. The Benefits of an APA • APA deals with future years: eliminates use of hindsight in making a determination as to how arm’s length parties would have conducted business. • Provides tax certainty for 5 or more years: allows taxpayer to reallocate resources, prepare improved budget forecasts. • No double taxation for APA covered transactions. • Cooperative process: taxpayer’s proposed TPM is usually accepted. If not, basis for decision is presented to taxpayer for discussions.

25. Benefits of an APA (cont’d) • Ability to discuss taxpayer’s transfer pricing issues anonymously and free-of-charge. • Nominal additional costs if managed correctly: current transfer pricing documentation and statement of expectations are sufficient. • An APA requires the taxpayer file an annual statement report to demonstrate compliance with the terms of the APA.

26. Benefits of an APA (cont’d) • CRA will usually agree to accept a request to “rollback” the terms and conditions of an APA to open tax years if facts and circumstances are substantially similar. • Once the initial APA has expired, renewals should be straightforward if the facts have not significantly changed – not always the case. • As transfer pricing audits increase and the issues identified by auditors become more complex, the APA Program may be appropriate. However, all potential issues must be considered before applying for an APA.

27. Costs & Risks • Initial investment of time and money: advisory fees and APA cost recovery amount. • APA process may require taxpayer to divulge sensitive information, but no more than what would be expected during audits. • Rare possibility that APA request will not be resolved with other tax administration. • APA may be resolved in a manner different than the one proposed in APA request (e.g. use of a different TPM).

28. Realities of an APA • Presentation of facts is as important as facts themselves. • CRA is aware that many companies are using the APA process to reduce taxes. • All important information must be provided at the time of filing a submission. • Although APA negotiations are generally principled, results are important.

29. Waiver of Penalty on APA and Rollback • A rollback will no longer be considered for Unilateral APAs • The CRA has a concern that corresponding adjustments are not being made to the tax returns of non-residents in situations where downward adjustments are allowed in Canada

30. Waiver of Penalty on APA and Rollback (cont’d) • A rollback, requested as part of a BAPA, will no longer be considered for a taxation year where the CRA has issued a 90 day letter. • However, if a taxpayer requests a rollback before the 90 day letter has been issued, it is equivalent to a voluntary disclosure. • Rationale: rollback is not intended to replace an audit or as a mechanism for avoiding an audit.

31. Waiver of Penalty on APA and Rollback (cont’d) • If a 90 day letter has not been issued, an auditor will not make a referral to the TPRC if an upward adjustment in a rollback year exceeds the penalty threshold. • This may create an incentive to apply for an APA in situations where contemporaneous documentation was not prepared for prior years as it reduces exposure to transfer pricing penalties that could come about in a random audit.

32. Penalty on APA and Rollback (cont'd) • A rollback, requested as part of an APA, will no longer be considered for a taxation year where the CRA has issued a 90 day letter. • Rollbacks are relevant where adjustments in previous (and often contention) years are significant. • However, if a taxpayer requests a rollback before the 90 day letter has been issued.

33. Why APA’s are/will grow in Importance? • Canada and India • Increased debts and deficits globally coupled with greater integration will lead to more aggressive positions taken by governments around the world. • Canadian, like Indian auditors have increased their audit activity. • More aggressive audits can be expected with taxpayers looking for resolution beyond the audit stage.

34. Why APA’s are/will grow in Importance? • In situations where tax disputes cannot be resolved at the audit level, an APA may be needed to resolve re-occurring and contentious transfer pricing issues. • An APA, when completed, will provide taxpayer with certainty. • APA’s are/will be a growing alternative to audits. • Many audits result in assessments that are inconsistent with similar audits performed in different regions of the country.

35. Why APA’s are/will grow in Importance? • An APA should be reserved for only contentious, re-occurring and/or complex issues and transactions. • Given an APA provides tax officials with intimate details of a company, an APA they should typically not be sought out by companies facing little audit risks. • An APA should be considered only under certain situations.

36. Trends in the Canadian APA Program

37. Trends in Canada: APAs Completed Annually

38. Intergovernmental Status

39. Intercompany Transactions

40. APAs by TPM (%) • Transactional Net Margin Method (TNMM) accounts for 53% of all APAs in progress. • Profit split and gross margin cost-plus methodologies each represented 19% of all APAs in progress.

41. APAs by Profit-Level Indicator (using the TNMM)

42. Participation in APA Program by Industrial Sector

43. Participation in APA Program by Industrial Sector

44. Countries which have APAs with Canada • CRA completed and negotiated APAs (including renewals) with 13 countries; • Approximately 74% of APA cases completed or in process are with the United States; • Japan, Australia and the United Kingdom account for the majority of the remaining cases

45. Country Country Completed Completed In Progress In Progress Total Total Australia Australia 7 7 1 8 Austria Austria 0 0 2 2 Denmark Denmark 2 0 2 2 France France 0 0 3 3 Germany Germany 1 1 0 0 1 1 Japan Japan 12 1 8 20 Korea Korea 0 0 3 3 3 3 Netherlands Netherlands 0 0 1 1 1 1 New Zealand New Zealand 1 1 0 0 1 1 Sweden Sweden 0 0 1 1 1 1 Switzerland Switzerland 0 0 3 3 United Kingdom United Kingdom 7 3 3 10 United States United States 97 6 61 158 1 Total Total 1 127 8 86 213 APA by Country

46. Conclusion • India is a fast growing economy which needs to provide multinational corporations with the tax certain conclusive to economic growth. • India has an aggressive audit system with little means of resolving double taxation. • An APA program, modeled on Canada’s program, can provide a means for corporations to resolve double taxation in India.

47. Conclusion (cont’d) • An APA is a collegial approach between 2 or more tax authorities that finds solutions to complex programs through a consultative manner. • An APA should only be considered for contentious and re-occurring transfer pricing matters that can’t be solved at the audit stage. • Given an APA “opens up” a taxpayer to added scrutiny, it should not be considered for taxpayers who face little audit risk.

48. Questions?

49. Presenter: Dale Hill Partner, Tax Services Tel: 613-786-0102 E-mail: dale.hill@gowlings.com