Transfer Pricing Strategy is Best Investment for US Companies Expanding into Canada
By Hendrik Swaneveld and Martin Przysuski
If your organization, like many US companies, is eying the Canadian marketplace for expansion opportunities, you would be well advised to integrate transfer pricing into your strategic business planning.
As global business growth sets a blistering pace, Canada, like many other high-tax jurisdictions, has noted a worrying increase in capital moving out of this country and into low-tax jurisdictions and tax havens. Determined to protect this valuable revenue source, the government has been introducing a steady stream of legislation, policies, procedures and resources targeted to eliminating international profit manipulation and securing its appropriate share of corporate profits.
Today, any company that transacts business involving goods, services or intangibles with related parties across Canada's borders needs to adopt proactive strategies in order to avoid problems and penalties with the Canada Customs and Revenue Agency (CCRA). Following are some of the most significant recent changes related to Canada's international tax programs.
- In June 1998, the government updated Canada's tax laws to reflect the principles promoted by the Organization for Economic Cooperation and Development. The legislation includes provisions to ensure that businesses use the appropriate transfer prices.
- The government has now specified the methodologies that organizations may use to calculate transfer prices.
- There is a new requirement for "contemporaneous documentation" which requires businesses to completely document their transfer prices, according to specified criteria, at the time the prices are established - not afterward.
- Filing requirements have been expanded to include more organizations. Along with the corporations that were always required to report their transactions with non-arm's length non-resident parties -- now individuals, trusts and partnerships must also file reporting form T106.
- Form T106 also includes new questions specifically designed to flag potential transfer pricing problems.
- New penalties have been introduced to encourage compliance. When a CCRA audit reveals transfer pricing discrepancies, the government may now impose a penalty of 10% on the total adjustment it makes to a transaction, plus interest.
- The CCRA has hired hundreds of international tax auditors to conduct more audits. These auditors will be examining more reporting forms, auditing more organizations and auditing organizations more frequently.
- In March of this year, the government issued revised guidelines for advance pricing arrangements in an effort to encourage more businesses to apply for APAs and thus avoid transfer pricing disputes and double taxation.
Companies Need to be Strategic
That's the bad news. The good news is that when organizations implement strategic transfer pricing programs, they benefit from numerous advantages:
- lower global taxes;
- a clear picture of marketplace position;
- identification of operational efficiencies and inefficiencies;
- improved costing systems and structures;
- awareness of how business functions, risks and resources impact profitability.
All of these benefits - along with the reduced risk of disputes and penalties -- are good reasons to adopt a strategic approach to transfer pricing. Following are some of the ways to go about this.
- Identify transfer pricing risks
For organizations that have transfer pricing programs in place, a risk assessment is a wise investment to identify any significant transfer pricing gaps or problems. This review involves just three steps, providing a cost-effective and efficient way to flag potential problems: identifying all transactions subject to transfer pricing; reviewing reporting form T106 to ensure all transactions and methodologies are properly disclosed; and identifying any deficiencies in policies, practices or documentation.
- Anticipate the results of an international tax audit
When the CCRA selects an organization for an international tax audit, a "mock audit" can minimize the risk that the examination will reveal problematic transfer pricing issues. This "dress rehearsal" of an international tax audit involves reviewing all of the questions and documents the CCRA would request in a typical audit.
- Prepare all required documentation
Canada's new tax legislation requires contemporaneous documentation for all transactions above Cdn$1 million with related non-residents. This involves preparing a detailed description of all significant facts related to these transactions. If an organization is audited by the CCRA and this documentation is not in place, it may face reassessment and penalties.
- Apply for an advance pricing arrangement
For organizations that anticipate transfer pricing problems, or those with a history of contentious relations with the CCRA, an advance pricing arrangement (APA) is a good investment. An APA is a formal agreement between the government and a taxpayer that confirms, in advance, the appropriate transfer prices for non-arm's length cross-border transactions. Securing an APA, however, involves significant resources, time and expertise, therefore this is an affordable option only for large multinationals.
- Conduct a transfer pricing study
The best way to ensure that your transactions comply with government requirements - and that you are paying the least amount of taxes required - is to conduct a transfer pricing study. This planned, documented analysis of the approach used in determining an organization's transfer prices includes six steps: identifying all key areas that should be included in a transfer pricing agreement with both parties; establishing all of the facts and circumstances regarding the transactions; characterizing the entities according to their business functions; selecting the transfer pricing methodology; identifying arm's length comparable companies; and preparing contemporaneous documentation.
If you want to reduce taxes and avoid penalties as you expand your company in North America, a proactive transfer pricing strategy could offer the best return on your new business investment.
Partner Hendrik Swaneveld and director Martin Przysuski are with the transfer pricing group of the Toronto region of BDO Dunwoody LLP Chartered Accountants and Consultants. They prepare multi-lateral diagnostic audits, transfer pricing studies and advance pricing arrangements for businesses conducting cross-border transactions and have developed a transfer pricing risk analysis checklist; for a copy, e-mail firstname.lastname@example.org
or call (905) 946 1066.