How Transfer Pricing Affects your Imported Goods

Trade Talk Blog • April 6, 2023

ransfer pricing is an important concept in international business and finance. It refers to the price set for goods and services exchanged between two entities that constitute part of the same corporate group or multinational enterprise (MNE). Transfer pricing allows companies to allocate taxable income across different countries, which can help with tax planning strategies. In this article, we’ll walk you through everything you need to know about Transfer Pricing.

What is Transfer Pricing?

At its core, transfer pricing is based on setting a fair market price for goods and services exchanged between related parties. The ‘arm’s-length principle‘ is used to ensure that transactions are conducted at such a rate as if they were dealing with unrelated parties. This means that prices should reflect what would be expected in a transaction between independent businesses, eliminating any form of profit shifting between related parties.

For example, a multinational textile manufacturer has multiple divisions, one producing fabric in Europe and another creating shirts in Canada. This Fabric Division acts independently when selling to both related Shirt Divisions and unrelated clothing manufacturers at the same price: an arm’s length transaction system is upheld. If the former opts for a reduced rate, though, their sales decline while profits rise on behalf of the latter; if they increase prices, however, sales will climb, but returns plummet accordingly.

Through the wise application of transfer pricing strategies, companies can reduce their tax liability and increase profitability. By setting a lower price on materials sold between divisions in high-tax jurisdictions, duty payments can be slashed while maintaining healthy margins.

Why Transfer Pricing matters

The necessity for transfer pricing arises because MNEs often have operations in multiple countries across the globe, subjecting them to different nations’ tax laws and regulations. Transfer pricing helps with taxation by mapping out a company’s profits based on their global operations while ensuring they pay their fair share of taxes in each country where they conduct business. In other words, it acts as an internal profit allocation tool within an MNE.

In addition to helping with taxation, transfer pricing also helps companies maximize profits from their global operations by improving operational efficiency. Companies use this system to coordinate activities across different subsidiaries worldwide, allowing them to benefit from economies of scale and optimize resources more efficiently without worrying about cross-border taxation issues or unfair advantages gained through improper revenue sharing amongst subsidiaries.

Why is Transfer Pricing adjustment important?

Transfer pricing adjustment is an important tool for corporations, especially international ones, as it allows them to align their global strategy with their economic and fiscal objectives. It enables companies to determine the most profitable way to transfer goods and services, as well as profits and losses, among different entities located in multiple countries that are part of one larger organization. This adjustment process should be considered part of a company’s overall financial planning and management process.

This approach can reduce potential costs from taxes, tariffs, currency fluctuations, or other external factors that may influence business operations worldwide. Transfer pricing adjustment also allows companies to manage risk more effectively by balancing the differences between local market prices and agreed-upon transfer prices among subsidiaries. In addition, it helps promote transparency between different regions within a company, given that each subsidiary has access to data from all other subsidiaries or branches. Due to the complexity of transfer pricing assessments and regulations, it is important for companies to partner with experienced advisors who can provide detailed knowledge about tax laws in various jurisdictions to maximize the efficiency of the entire process.

All in all, transfer pricing adjustment is an integral component of any successful multinational corporation’s financial planning and control processes since it serves as a mechanism by which they can better manage their tax burden across countries while still meeting their strategic objectives.

When do Canada’s Transfer Pricing rules apply?

Canada’s transfer pricing rules apply when:

• There are two or more entities involved
• At least one of the involved entities is a Canadian taxpayer — this includes non-resident entities that are taxpayers for Canadian tax purposes
• The transaction is cross-border involving Canada
• The Canadian taxpaying entity and at least one of the offshore parties enter into one or more transactions and are not dealing at arm’s length

Transfer Price study

To ensure that related parties engage in fair and unbiased transactions, companies should perform transfer price studies at the end of their fiscal year. However, given that the business model remains the same, a transfer study can be used over several years.

The Organisation for Economic Co-operation and Development Model Tax Convention prescribes Arm’s Length Principle to guarantee equal treatment — a concept wherein two commonly controlled entities act as if they are independent during such negotiations. This practice is beneficial not only to organizations but also helps various governments collect due taxes from these transactions.

As an importer, it is important to know the aggregate payments made or payable for imported goods. This total cost goes towards determining their value according to Customs Act regulations.

Adjustments

Adjustments to the value for duty reported to CBSA should be made within 90 days of Reason to Believe after receiving specific information that a transfer price adjustment has occurred.

However, this process must include specific evidence in the form of a submitted Adjustment Request to avoid any potential Administrative Monetary Penalties (AMPs) being applied as a consequence.

Penalties

If adjustments are made, importers may face Administrative Monetary Penalties (AMPs) for failing to make reasonable efforts to verify their compliance with the arm’s length principle — including interest. If you fail to account for the correct transfer price adjustment, you may be penalized under C083 or C353 of the Administrative Monetary Penalty System.

C083 refers to importers who fail to make required corrections within 90 days of reason to believe the declaration is incorrect while C353 refers to those who fail to pay duties resulting from corrections within 90 days of having reason to believe a declaration was incorrect.

Under C083 and C353, importers will be penalized $500 to a maximum of $5,000 (per issue) or $25,000 (per occurrence) for the first offense. The penalty rises to $750 to a maximum of $200,000 (per occurrence) for the second offense, and $1,500 to a maximum of $400,000 (per occurrence) for the third and subsequent offenses.

To ensure your financial decisions meet standard regulations and avoid any potential consequences due to noncompliance, you should document these judgments clearly and transparently to demonstrate adherence to the arm’s length rule.

Conclusion

Transfer pricing is essential in today’s global economy as it helps with proper income allocation while allowing firms to benefit from economies of scale created by multiple operations worldwide. However, companies must comply with arm’s length principles to avoid potential conflicts with CBSA and tax authorities and maintain fairness among related parties involved in intercompany transactions.