The German giants negotiated the clause when they signed the Portugal international on loan for the rest of the season in January.
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Cancelo, 29, helped Bayern win the Bundesliga at the weekend but has had a mixed spell at the Allianz Arena.
And the decision has been taken by boss Thomas Tuchel and the club not to extend his stay in Bavaria.
City chief Pep Guardiola gave him the green light to move after the defender lost his starting place and made his feelings known.
Cancelo’s chances of forcing his way back into the reckoning at the Etihad appear slim as the side have coped well without him.
Barcelona are keen on the ex-Juventus man but Treble-chasing City may have to drop their asking price to get rid of him.
Meanwhile, transfer guru Fabrizio Romano also states that Arsenal are lining up a shock swoop for the defender.
He claims that Barca have had “genuine interest since January” in Cancelo but any potential move “depends on FFP”.
However, he added that “Arsenal appreciate Cancelo” and that “he’s one of the names in the list” of potential targets for boss Mikel Arteta.
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Gunners left-back Kieran Tierney looks set to depart to the Emirates over the coming weeks.
Aston Villa manager Unai Emery is allegedly hoping for a reunion with the Scottish ace at Aston Villa while Newcastle are also keen on the ex-Celtic man.
And that could free up room for Arsenal to land Cancelo.