How does transfer pricing impact importers in Canada?

Transfer pricing can be a vital strategic tool for companies that create goods or provide services in multiple countries. A multinational enterprise (MNE) that imports goods from a business group in another country to a related group in Canada can strategically plan the price of these intra-group transaction to maximize profitability.

Companies that leverage transfer pricing can reduce tax liabilities, create healthy margins, and contribute to financial objectives for multiple business groups. However, companies must follow transfer pricing regulations outlined by government bodies, like the Canada Border Services Agency (CBSA) and the Canada Revenue Agency (CRA), to avoid penalties and fines for issues such as failing to declare the correct value of imported goods.

How does transfer pricing work?

The concept of transfer pricing focuses on the trade of goods that are exchanged between two related business parties. A MNE in Turkey that sells fabric to a related clothing manufacturer in Canada can determine the price of the fabric. If the Turkish arm of the business sells the fabric to the Canadian arm at a discounted rate, the latter would register improved profit due to lower costs. If the MNE decides to set the price of the fabric at a premium rate, the Turkish arm of the business would experience improved profits.

Transfer pricing allows companies to shift costs, profits, and resources from one business group to another. Doing so can significantly change the finances of each business group in the MNE. A company can pay lower taxes, duties, and tariffs by adjusting the transfer price of goods, including adjustments made a few months after the transaction.

This doesn’t mean that MNEs can decide to set the price of good to whatever benefits them the most. In fact, companies must set fair market prices for goods and services provided from one related business group to the other. The goal is to ensure that transactions that involve transfer pricing occur at market rates that are similar to deals between independent and unrelated parties. Typically, this is known as the “arm’s-length principle”.

Arm’s-length principle for transfer pricing

The arm’s length principle is applied when business transactions take place between two related parties. Conceptually, maintaining an arm’s length means that the transaction takes places as if the two parties are not related. A fabric producer selling to multiple clothing manufacturers must apply a similar rate when selling to a related garment maker.

The arm’s length principle aims to prevent illegal profit shifting among related corporate groups and business parties. At the same time, the principle helps to maintain fair market prices, promoting competitive fairness and better transparency for MNE financial transactions. Government agencies, including the CBSA, monitor transfer price for income tax, duty payments, and other purposes.

An arm’s length principle is essential for cross-border transactions within multinational corporations. Without it, there's a greater risk of price manipulation to minimize taxes, duties, and tariffs or unfairly benefit at the expense of others, including competitors and consumers.

Rules for transfer pricing in Canada

Transfer pricing legislation in Canada requires that multinational groups apply the arm’s length principle when creating an agreement to buy and sell goods between related business groups. In a nutshell, these types of transactions have to be “priced properly” for the Canadian entity to report an accurate profit for taxation.

The CBSA considers the transfer price of agreements between vendors and related purchasers as the “uninfluenced” price for the goods. MNEs can submit data to establish that goods traded between internal groups are priced properly and sold for an uninfluenced price. Some companies provide transfer pricing studies at the end of their fiscal year to show that they engage in unbiased, arm’s length transaction.

MNEs will voluntarily declare an adjustment to the value for duty declared to CBSA for a fiscal year, based on results from year-end transfer pricing true-ups. This generally results in a difference between the financial statement tax expense and actual tax liability on the tax return.

MNEs have the ability to adjust the declared value of goods within 90 days by reporting an adjustment. Companies can report to the CBSA with data that shows a change in the transfer price. You’ll need to include evidence as part of an adjustment request to the CBSA. Failure to do so can result in Administrative Monetary Penalties (AMPs) and other significant problems for your imports.

Transfer pricing is an essential aspect of allocating income correctly among multiple business groups under the same umbrella. Let an experienced professional support your import processes to ensure that shipments stay on track while complying with regulations. Contact one of our customs brokers to learn more.

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