New U.S. tariffs on Canadian goods could force multinational entities (MNEs) to reconsider their transfer pricing strategies to mitigate exposure to tariffs. Here are some approaches MNEs could take to prepare for potential tariffs.
Canadian businesses face rising costs and trade uncertainty as the threat of U.S. tariffs lingers—but adopting new transfer pricing strategies could be an avenue to provide some relief.
Multinational entities (MNEs) are subject to transfer pricing rules that govern intercompany prices for goods crossing borders. Tariffs add another layer of consideration for managing transfer prices. Higher tariffs incentivize MNEs to lower the transfer price of imports to minimize duties, while lower tariffs may encourage shifting profits to lower-tax jurisdictions.
However, aggressive pricing adjustments could trigger transfer pricing audits from tax authorities. Balancing tariff optimization with compliance could allow companies to reduce tariff exposure while maintaining compliance with tax regulations and steering clear of excessive audit risks.
Understanding the intersection of trade policy and transfer pricing is critical for any MNE with transactions between Canada and the U.S. to develop a platform to reassess their structures.
Here is a look at three potential approaches to transfer pricing which could help mitigate the impact of tariffs.
Tariffs generally were not a significant consideration for transfer pricing policies between Canada and the U.S. due to the countries’ historically strong trade relationship.
Other taxes such as withholding taxes (WHT) were often more pertinent. As a result, many businesses adopted a straightforward approach to transfer pricing, such as targeting a distribution margin.
While targeted margins may have been efficient, they may not be ideal when tariffs are considered. There may be other transactions, such as services, that should exist and would reduce the intercompany transfer price of goods.
When considering future strategies, it is important for MNEs to review whether past practices were in fact the most appropriate. By reassessing prior situations, MNEs can identify areas where adjustments may be necessary to better align with the current tariff landscape.
Companies evolve over time, but transfer pricing strategies may not be updated as quickly.
Consider this scenario: a business starts with two or three sales individuals and distributes Canadian-purchased products in the U.S. through a U.S. subsidiary (USCo), which is compensated with a target operating margin. Over time, the USCo hires executives and establishes its own HR, IT and other functions.
The historic transfer pricing policy may no longer reflect the actual risk and functionality of the USCo. Additionally, new comparable arrangements may have been struck with an arm's length distributor, which could serve as a strong comparable uncontrolled price (CUP). Reviewing these facts may lead to a position that results in the intercompany sales price being lower than what it was historically.
There are many supportable methods to price intercompany transactions, and each may result in different intercompany prices. MNEs should explore alternative transfer pricing to ensure they are using the most appropriate and beneficial approach amid the potential enforcement of new tariffs.
Goods resold by a Canadian or U.S. company can have components, and not all components may originate from or be further processed in either country.
Understanding a company’s supply chain may identify these facts. This presents a potential opportunity to bifurcate the goods or components sold, since it’s possible that not all goods sold will face tariffs if their point of origin is another country.
By conducting this analysis alongside trade advisors and transfer pricing experts, MNEs can identify opportunities to effectively deal with tariffs.
The potential introduction of tariffs between Canada and the U.S. presents new challenges for MNEs—but there are planning opportunities available.
Aligning transfer pricing with trade and tax compliance is critical to managing costs and avoiding regulatory challenges. As protectionist policies grow, Canadian companies must navigate these disruptions to stay competitive.
Given the potential financial implications, it is essential for companies who trade between Canada and the U.S. to consider these factors carefully and develop effective transfer pricing strategies.
Ryan Belo, Associate
