U.S. Tariffs: Should you Revise your Transfer Prices?

How can a Canadian company operating in the United States mitigate the impact of the tariffs that Donald Trump might impose?

Uncertainty remains regarding the imposition of tariffs on Canadian goods exported to the United States, but Canadian companies have to be prepared. If your organization conducts business on American soil, you must think about the options available to you and establish an action plan.

Transfer price vs. value for duty

It is important to first make the distinction between the concepts of transfer price and value for duty.

Transfer prices are the prices that related entities located in different countries apply on all their transactions. They have to be established according to the arm’s length principle and are subject to specific tax rules aimed at protecting each jurisdiction’s tax base.

Tariffs are not applied to transfer prices, but rather to value for duty . When related parties conduct a transaction, the importer must demonstrate that the relationship between them does not affect how that value is determined.

A decrease in transfer prices that is not supported by real operational changes may not result in an equivalent decrease in value for duty. Furthermore, such a decrease could result in an adjustment from the Canada Revenue Agency (CRA) in the course of a tax audit.

Different reorganizations to consider

Canadian companies that are already active south of the border could reorganize their operations in order to increase the proportion of activities conducted in the United States.

One option would be to convert a sales office into a distributor. The Canadian company would then sell its products to its U.S. distributor, which, in turn, would resell it while retaining a profit margin. The value of goods going through customs would therefore be decreased to take into account the distributor’s operations in the United States.

A Canadian manufacturer could also transfer some of its functions to a related U.S. company. For example, a Canadian company could sell parts to a U.S. subsidiary, which would be responsible for assembling the finished products and selling it to customers.

A Canadian company could also change statuses, from being a manufacturer to a subcontractor. In that case, the U.S. company would own inventory and goods, but subcontract manufacturing in Canada. Such an agreement could nevertheless be impacted by tariffs and should be thoroughly analyzed once the ground rules are clear.

These kinds of reorganizations necessitates a review f the transfer pricing policies, and could thus result in a decrease of the value for dutywhich is subject to tariffs.

The importance of properly documenting reorganizations

As mentioned above, any change in transfer pricing policies must be supported by concrete operational changes. These changes should be made with a mid to long-term perspective, and not be seen as a temporary measure.

It is also critical that companies maintain transfer pricing documentation in order to justify changes in operations and transfer pricing policies. In the current situation, we expect tax authorities to be on the lookout and conduct audits to determine whether the rules were followed. Companies that revised their transfer prices downward without valid cause could be subject to adjustments to their taxable income and, in some cases, face hefty penalties. Transfer pricing documentation could also prove useful during an examination by the customs authorities.

To determine the best strategy for your specific situation, consulting your tax specialist may be a wise decision. They will be able to help you assess the different possible scenarios and, depending on the circumstances, choose the best option for you.