Recent trends in transfer pricing are placing a renewed emphasis on transfer pricing compliance by businesses of all sizes and underscore the utility of a unified approach to tax and customs transfer pricing that optimizes benefits derived from dual planning and minimizes costly and protracted disputes. In this update, we highlight these key trends and discuss features and benefits of the unified approach.
Our knowledge of recent trends in transfer pricing stems from experiences of enforcement by revenue authorities seeking compliance and, notably, additional taxes and/or duties (in Canada, the Canada Revenue Agency (CRA) and the Canada Border Services Agency (CBSA), respectively). In particular, consider the following:
CRA and CBSA, as well as counterpart government revenue authorities in other countries (notably the IRS), are increasing staffing, with the result that taxpayers/importers face a greater likelihood of audit. Small and medium-sized businesses, which have not traditionally been viewed as targets, should no longer assume their transfer pricing practices are “below the radar”.
The CBSA, in particular, is undertaking more detailed, customs valuation (program-specific) audits, and in those details lie transfer pricing practices. As a result, importers should expect to face more thorough scrutiny of purchase pricing in related party sales of goods transactions.
The CBSA has begun to re-characterize as dutiable “subsequent proceeds” what are otherwise non-dutiable payments (e.g., marketing, IT, management, accounting/bookkeeping, legal, etc. services and licence fees) that are not supported and cannot be sufficiently linked to benefits derived by importers of goods purchased from the service provider or its related group of companies.
Revenue authorities are coordinating their efforts through information sharing, resulting in more businesses facing multiple audits. Audits can be very costly in terms of diverted internal resources even if the taxpayer/importer succeeds.
The authorities, notably the CRA and to a greater extent than in the past, the CBSA, are becoming much more aggressive in assessing penalties. In the income tax context, the implications are material, non-deductible cash penalties. Moreover, failure to meet the contemporaneous documentation requirements may place taxpayers in a deemed penalty situation.
Cross-border businesses face increasing risk of double taxation as governments aggressively seek more tax revenue by tightening transfer pricing regulations and practices. The contrary positions of the IRS and CRA on management fees (including a profit element versus straight cost allocation) is just one example that will have a potentially significant impact, especially on Canadian subsidiaries paying management fees to US parent companies.
These enforcement trends inform taxpayers and importers/exporters of the need to be vigilant and proactive about transfer pricing compliance. However, the news is not all bad. Recent changes and trends may be creating transfer pricing opportunities and benefits for businesses. In particular:
Canada has traditionally been a high tax jurisdiction with the result that companies' transfer pricing policies have been aimed at reducing Canadian income in favour of that of related parties in other jurisdictions. However, with Canada's corporate tax rates trending downwards and expected increases elsewhere, including the US, now is an opportune time for businesses to take a fresh look at their transfer pricing planning to enhance the overall tax efficiency of their international structuring. For optimal benefits, however, it is essential to adopt a unified approach that includes customs as well as tax impacts.
The Canada-US Competent Authority procedures, which are government-to-government negotiations involving taxpayers subject to double taxation, have recently been enhanced with mandatory, baseball-style (last best offer) arbitration procedures. While still very new, these procedures are expected to encourage the Canadian and US competent authorities to adopt more reasonable positions that better mitigate double taxation.
The ongoing practice of the CBSA to deny refunds of duties and interest that should result from downward adjustment of transfer pricing of imported goods is being challenged, and if successful, will afford opportunities to seek refunds for importations made within four years of the date of refund application.
Given the significance of transfer pricing risks and opportunities to the bottom line, it is important for businesses to take a unified approach in developing robust but practical transfer pricing policies and practices. In particular:
Contemporaneous documentation should meet the standards of all interested revenue authorities. In our experience, transfer pricing studies are often insufficiently detailed for customs purposes, especially when there are multiple transfers (e.g., goods, IP and/or services). Moreover, contemporaneous documentation cannot be static: it should be updated regularly and also when business circumstances change (e.g., new business line, changing competitive environment). It is also necessary to maintain internal supporting documentation from which transfer pricing studies have been developed. This is particularly important in the customs context because non-dutiable elements are scrutinized to ensure payments are for services or IP rights actually received.
Transfer pricing does not end with contemporaneous documentation. Instead, a unified approach that coordinates commercial agreements and business practices with arm's length transfer pricing and other terms is essential in today's enforcement climate.
A coordinated approach to transfer pricing is especially important in the context of transfer pricing adjustments where there is a natural tension between customs and income tax (e.g., customs valuation (duty) vs. COGs (profit/income tax)). Moreover, different reporting periods (customs transfer pricing reporting is transactional but income tax reporting is based on fiscal periods) make handling adjustments potentially complex.
The inherent tension in customs and income tax transfer pricing, coupled with greater coordination of enforcement actions by revenue authorities, also mandate a tax and customs unified approach to transfer pricing audits or voluntary disclosures.