Dan McGeown:
Well, it's very dangerous because anybody who's been through a transfer pricing audit or a customs audit knows that the devil is in the details. And unless you've examined all of the details and you have everything factually correct, it would be impossible to say that getting information from a third party is going to fit your company's transfer pricing and/or customs.
Charmaine Goddeeris:
Welcome to the BDO Cross-Border Tax Podcast, where we bring you insights and strategies on complex international tax and trade issues that are shaping global business today. I'm Charmaine Goddeeris, Director and lead of the Customs & International Trade practice here at BDO Canada. In this episode, we're diving into how companies can effectively navigate tariffs through transfer pricing. With global trade tensions, supply chain disruptions, and raw material cost-spiking creating volatility, even the most established transfer pricing plans face new challenges. I'm joined today by the esteemed Dan McGeown, and my best friend Hilary Coates from our transfer pricing team. We'll discuss how businesses can adapt their intercompany pricing to reflect arms-length principles amid changing cost structures, align customs values, and transfer pricing to mitigate risk and implement advanced strategies to manage tariff exposure while maintaining compliances with all of those rules and regulations. Dan and Hilary, welcome and thank you for being here today.
Dan McGeown:
Thank you for having us.
Hilary Coates:
Thank you, Charmaine.
Charmaine Goddeeris:
I think we should jump right in. So, a lot of the questions that I'm going to ask you today, both of you today, I've actually gathered from clients, companies that I've talked to during my tour, of the country in the fireside chats. So these are real life questions that myself and you guys have been asked along the way. So, here we go. Number one, how have tariff changes impacted companies with existing transfer pricing policies? And are these changes forcing companies to reconsider their longstanding pricing methods?
Dan McGeown:
So, let's take a look at this, and we'll have, to frame out this conversation, we'll consider a Canadian manufacturer who designs the product selling to its related US distributor. Now, transfer prices are usually set with a profit expectation in mind, and that profit expectation comes from a set of comparable distribution entities that we just refer to as comparables. And if you can imagine the tariff costs now coming in to the US distributor, the profits may fall below the arms-length range of profits that we expect for transfer pricing. That would signal that your transfer pricing may be considered offside or incorrect. It won't be arms-length. So it is forcing companies to reconsider their transfer pricing policies in terms of do they come up with new methods trying to adopt a new transfer pricing method, or do they consider other factors such as seeking out new suppliers, third-party suppliers so that the distributor is dealing with a third party? Could the flow of products be changed such that we are mitigating the cost of the tariffs, or should the company find new suppliers elsewhere, or reroute their supply chain?
Charmaine Goddeeris:
Yep. Exactly. Hilary, you're in the hot seat now.
Hilary Coates:
Uh oh.
Charmaine Goddeeris:
What early indicators should finance and tax teams at companies look for that suggest it's time to review or recalibrate their transfer pricing studies directly in response to the current tariff volatility?
Hilary Coates:
Yeah, it's a really good question, and unfortunately we've had little to no guidance from the OECD, or the Canada Revenue Agency, or the IRS on how to navigate these uncertain times. So, early indicators in our experience with meeting with clients and helping them navigate all the changes that have happened in the last several months is one big indicator would be profits falling below the arm's length range in the distribution company, you know, using Dan's example. Or losses even being incurred, either in the parent company or the distribution company where there previously were no losses. Declining sales volume and market share indicate that the tariffs have had an impact on the market and the company needs to respond to that from a business perspective as well as a transfer pricing perspective. And if the organization is operating in the US through a distribution company and that distribution company is the importer of record of the goods into the United States, some serious thought needs to be given to who's going to bear those tariff costs if they cannot be fully passed on to customers. Should they be borne entirely by the US company or should the cost be shared by the Canadian company as well? And like I said, we don't have much guidance from tax authorities on that, so it's something that we're looking at on a case-by-case basis.
Charmaine Goddeeris:
Amazing. Okay, when supply chain disruptions and raw material prices spike and it causes volatility, what practical steps can companies take to keep the intercompany pricing aligned with the arm's length principle?
Dan McGeown:
As you look at this, you have to consider, is this going to be a short-term phenomenon or is it going to be long term? Whether it's short term or long term, I mean, one of the first steps would be trying to negotiate new deals with your customers and possibly your suppliers so that you share in the pain but are still able to keep everything on side in terms of arm’s-length transfer pricing. One of the things that you could consider if it's short term, is do you provide something like a market support payment to your distributor to keep it within the arm's length range until you get to that short term period? That obviously would not work as a long-term solution, but you would look at things like that mechanism to keep the companies on side as best as possible.
Charmaine Goddeeris:
Right, right. So Hilary, I'm going to punt this one to you if that's okay. How important is it to keep good, timely documentation when you're making transfer price adjustments? Because costs are sort of jumping around. If I think of certain areas like steel or copper, that would've regularly fluctuated anyway, and now they have this additional pressure on them with tariffs, et cetera. So again, how important is it to have that timely, you know, documentation so that they can make the appropriate adjustments with raw materials? And can you share some real examples of how companies have done this in the past?
Hilary Coates:
All right. It is another really good question. I think now, more than ever, it's vitally important to make sure you keep both your transfer pricing documentation and your customs documentation current and to ensure you take any steps necessary to reconcile any differences between your transfer price and your value for duty. As Dan mentioned earlier, I think communication with your suppliers and your customers is critical because we're all facing similar challenges and it may be necessary to renegotiate existing agreements. It may also be advisable to take into account long-term plans that may need to be accelerated to the short term. And at the same time, not making any knee jerk reactions that could be damaging in the longer term. So, yeah.
Charmaine Goddeeris:
Perfect, and I'm thinking of I don't work with CRA, CBSA, and other federal agency, and as I'm talking to my clients right now, I'm saying one of the most important things that you can do is ensure that you've got a robust record keeping and documentation plan in place. Because guess what? You know, we, we all know where the government, and it can be in the US, it can be in Canada, we know where the government gets their money, they get it from the taxpayer, and they get it from collecting taxes. And on both sides of the border, economies are a little shaky right now, and the governments need some money. So what are they doing besides increasing tariffs, and that's a discussion for another podcast. But what they're doing is ramping up their audit activities, right? So from the customs perspective, it's not a, "I might get audited in the future." It's a, "You're going to get audited in the future." And we saw that back in 2017 when the first Trump administration, the first trade tiff, we'll call it, it wasn't a trade war, a trade tiff, and we had steel and aluminum tariffs on both sides of the border. You know, two years went by and then finally, CBSA, Canada Customs, came in and started auditing what you were doing two years ago. Were you paying the correct amount of punitive tariffs and surtax? Were you doing anything untoward? So I think that's a, as you said, I think that's a great piece of advice that, gosh, you’ve got to keep that record keeping in good standing right now.
Dan McGeown:
Yeah, so we have, so I'll just pick one of our clients where they had determined their product pricing years ago based on an old customs audit. And that price was actually too high for the product. So they called us in and asked us if there was anything they could do. And we thought, well, we're going to have to do a full blown analysis to determine what that should be. And that analysis would need to include transfer pricing, customs, international tax, and legal, just to make sure that we come up with a solid solution. It turned out that the product pricing could be reduced significantly. There were other transactions bundled in with the product pricing, and when you unbundle those transactions, you can reduce the product price, but because you've got these other transactions at play, your profit level, that to get a distribution profit that's arm’s length, it remained more or less the same, but it took a lot of analysis. They now have transfer pricing documentation, and customs documentation, and legal agreements that support everything that they're doing at this point in time.
Charmaine Goddeeris:
Good. All right. Why is it important to align customs valuation with transfer pricing rules across the countries?
Hilary Coates:
Well, customs and transfer pricing auditors generally have the opposite mindset. So when, if the US Customs and Border Patrol is auditing a client's value for duty, they're probably inclined to think it's not high enough because if it was higher, there'd be more duties. Whereas a transfer pricing auditor is probably going to say that price is too high. So we've always got these forces that are at odds against each other. And of course, customs rules differ from country to country, and transfer pricing rules differ from country to country, even though most countries, that we deal with anyway, follow the OECD guidelines, they interpret them differently. So it's very important to know what countries you're operating in and how they view both customs and transfer pricing, and how do you bring those two together so that you can convince everybody involved that the pricing is correct for both purposes. And that's a big challenge. So, like Dan said in his example, it's really important to look at the transaction flows, and price what you can as accurately as possible, and then make sure that you're not falling into any trap where something that you unbundle could inadvertently actually be included in the value of your duty.
Charmaine Goddeeris:
You know, I think it's a good time and an important thing to mention to our listeners is that any time you have goods moving across the border and there's related party transactions, your customs group and your income tax group transfer pricing cannot act in a silo. We don't here at BDO. I mean, for the past six months, Dan, Hilary, or I have been on multiple calls because we need to be. And as Hilary said, well there's some similarities in customs transfer pricing related party pricing. There are some key differences as well. So yeah, for our listeners, if you're going down this path and you're thinking about starting up business in the States with a related party, or you have an existing one, make sure that all of the relevant team members are at the table and talking, because one move on the income tax trend for pricing side can have a really negative effect, and vice versa. Okay, so this is a great question that I'm going to say next. And it's funny because I believe it's almost a real life example from a client call, or a maybe a client call, scoping call that Hilary and I had yesterday. So here it comes, Hilary, but I think it's for Dan. What are the risks-
Hilary Coates:
It's for Dan.
Charmaine Goddeeris:
of arbitrarily setting prices for customs purposes without considering income tax and transfer pricing regulations? So, we did have a call yesterday where the company, you know, ABC Co, they picked up the phone and they called their competitors and said, you know, "What are your margins, et cetera. How much can we cost?" They gave them a number, and then they came to us and said, "Is this a good number?" And Hilary's like, "We need to look at your business. No, not what the Joneses are doing down the road, what you're doing." So what, what about that, Dan? What do you think about what the dangers or the risks are of just picking a number out of the air and going, "This is what we're going to use"?
Dan McGeown:
Well, it's very dangerous because anybody who's been through a transfer pricing audit or a customs audit knows that the devil is in the details. And unless you've examined all of the details and you have everything factually correct, it would be impossible to say that getting information from a third party is going to fit your company's transfer pricing and/or customs.
Charmaine Goddeeris:
Exactly, and you're also making the assumption that the Joneses down the road know what they're doing. Maybe they don't, maybe they just picked the number out of the air from their neighbors. Exactly. Each study is-
Dan McGeown:
It's quite possible.
Charmaine Goddeeris:
Quite possibly is unique to their specific situation and all the details of their situation need to be reviewed in detail. That's fair?
Dan McGeown:
That's fair.
Charmaine Goddeeris:
All right.
Hilary Coates:
Like you said, Charmaine, we try not to operate in a silo. So transfer pricing and customs, we collaborate, but we also work with our colleagues in U.S. Tax, Canadian Tax, International Tax. There's complicated issues like withholding tax, FAPI rules, even, if you're setting up a new US company, where do you put it in your structure so that it makes sense from a US tax and a Canadian tax perspective? So, it's not straightforward and there's no one-size-fits-all solution.
Charmaine Goddeeris:
No, and I learned stuff on that call we did this morning with a client that was looking to set up business in C Corp versus LLC, and then some other things going in there, where we're always learning. And I think the takeaway there is get help, reach out to your local tax advisor, get some help. Okay. For companies with mature transfer pricing plans, what strategic adjustments can be made to mitigate the impact of tariffs without compromising compliance?
Dan McGeown:
What I think, Charmaine, this kind of goes back to mechanisms such as the market support payment I mentioned earlier, wherein if you've got a mature transfer pricing policy and there really is, other than the impact of the tariffs, there really is no reason to abandon it, how do you get through, on a short term basis, with a mechanism that shows you're paying attention to the facts at hand. The Canadian parent company is the manufacturer, it designed the product, it does all the heavy marketing and all of that. US company's more of a simple distributor. So let's keep the profits in line with the characterization of the entities the way that it is.
Charmaine Goddeeris:
How does supply chain restructuring and transactional flow adjustments interplay with transfer pricing policies to manage tariff exposure effectively?
Hilary Coates:
Yeah, this question kind of overlaps with an earlier question where I think many multinational groups need to consider whether they need to restructure their supply chain or possibly make adjustments to the transaction flows. And that requires a fairly robust transfer pricing analysis that also factors in the customs implications and allows for playing with some variables to see what the impact is on both parties that are involved in the transactions. You know, over the long term some companies may plan on moving their production from, say, one country to another country, and they may want to accelerate that if they can. On the other hand, even if they do that the landscape is constantly changing and they may have to make further reactions down the road. So I think planning things out and trying to stay as cool as possible and consider all the possibilities will allow companies to make the right decisions, as opposed to just knee jerk decisions.
Charmaine Goddeeris:
Yeah, no I think you said a couple of great things there, and say this a lot as I am talking to clients and companies. Okay, let's all take a deep collective breath, no knee jerk reactions, and let's create the plan, because there's things out there that are happening that we can't control. What can you control though? You control your business and what your supply chain looks like, what your transfer pricing looks like, let's focus on what we can control because there's just too much volatility out there. So, Dan, what are the most common audit triggers when companies update transfer pricing to respond to tariffs?
Dan McGeown:
Most common audit triggers are a change in the profit expectations in both countries. It is sure to get the tax authorities excited when they cease. For example, the profits in Canada go down while the profits in the US go up. If you now, and we talked about unbundling, but if the CRA suddenly sees a number of transactions they may take issue with the various transactions, they didn't see them before. And on the flip side, if you eliminate a transaction by going to a third-party supplier, that will also pique the tax authority's interest. They like to see things continue on year upon year, as long as they're getting their profit in tax.
Charmaine Goddeeris:
Exactly. Exactly. Hilary, what recommendations can you give to companies to maintain a strong compliance posture and avoid costly disputes?
Hilary Coates:
Yeah, this, I think, always trying to be prepared, and as Dan frequently says to a lot of our clients, is make sure you have evidence, evidence, evidence of why you did what you did. So what we recommend to our clients is performing a robust analysis that gets documented for customs purposes, transfer pricing purposes, international tax purposes. We want to make sure we don't miss any compliance issues like withholding tax on certain payments, or foreign accrual property income issues on certain types of transactions. Expatriate taxation is always an issue, if we have people crossing borders. It's not just about goods crossing borders, but if people are crossing borders, you can create issues for those individuals and the company. So things overlap, and they can get very, very complicated. So I think always making sure that you're aware of the issues, you know when you have to file things, and you know what evidence you need to have on file to support positions you've taken so you're in the best position to defend yourselves.
Charmaine Goddeeris:
Exactly, and that feeds into the whole conversation of being audit ready. And I agree, I think even from my customs perspective, and I'll reiterate this again, record keeping, record keeping, record keeping. Because if you don't... You can say whatever you want in your rebuttal to a government agency, but if you don't have the documentation to support, good luck to you. Good luck to you. Okay, Dan, last question. How can cross-functional collaboration between tax, finance, and customs teams improve audit readiness?
Dan McGeown:
Well, see, and as we've been talking about all along through this podcast is, is the fact that we do need cross-functional expertise brought to bear on these issues because there is an interplay between transfer pricing, customs, legal, international tax, and so it should be approached as a team effort, not transfer pricing looking at it in a silo, customs looking at it in a silo. It really has to be a cooperative effort. And so within your company, you should pull those teams together and make sure that they're working congruently, and then with your advisors, ensure that you're getting that from your advisors as well.
Charmaine Goddeeris:
Exactly, and I can speak to what we've done here at BDO Canada, if any of our listeners have visited our tariff readiness page, what you will see on there is a whole team that has been created here and it has not just me from customs, it's got you guys from transfer pricing, international tax, SVAC, we can draw in legal if we need, if there's visa issues crossing the border. So I think that was a really great comment, Dan, is mirror that at your particular company and create this tariff readiness team. Well, this has been really good. Thank you Dan and Hilary for sharing your valuable insights. And to our listeners, thank you for joining us on the BDO Cross-Border Tax Podcast. For more guidance on customs valuation and transfer pricing matters, please visit bdo.ca or “Tariff readiness” at BDO and you'll find us. If you found this episode helpful, we would appreciate a five-star rating and review. Be sure to follow us to subscribe so you don't miss any future episodes packed with practical advice to support your cross-border tax strategies. We look forward to connecting with you again soon. Have a great day and thank you very much.