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Companies established in many countries cannot escape transfer pricing.
Transfer prices are the prices at which related entities located in different countries trade, including the sale of goods, services or intellectual property.
In Canada and most countries, these prices must be established by respecting the arm’s length principle, which stipulates that the conditions for related entities’ transactions must be the same as those that would have been agreed upon by non-related entities.
While companies established abroad must comply with transfer pricing rules, they can also use them to optimize their tax situation. Therefore, it is in their best interest to know these rules as soon as they plan on expanding abroad.
A planning tool
The proper use of transfer pricing can help a group minimize its tax burden. In fact, economic theory states that the greater the work performed, risks assumed and assets held, the higher the expected returns. Therefore, it would be to a group’s benefit if value-added functions, valuable assets and high risk activities were within a jurisdiction with a lower tax rate since a greater portion of the group’s profits will be taxed at a favourable rate.
Documenting transfer pricing
The Canada Revenue Agency (CRA) is one of the most aggressive tax bodies in the world when it comes to auditing transfer pricing. When it deems that the arm’s length principle is not being observed, the CRA can adjust the transfer pricing and impose a penalty. This penalty will apply if the adjustment increase exceeds the lesser of $5,000,000 and 10% of gross income.
However, the penalty will not apply if the taxpayer can prove that, through transfer pricing documentation, serious efforts were made to comply with the arm’s length principle. This documentation is therefore essential for companies established abroad as it must provide a complete description of transactions between the group’s entities and demonstrate the method used to determine the transfer pricing.
Your Raymond Chabot Grant Thornton consultant can help you better understand these issues.