Expanding your business into new jurisdictions can unlock many benefits and opportunities; however, there are key factors to consider before taking the leap. One factor that often gets missed is transfer pricing.
As you prepare to deploy your valuable brands, products, technologies, and/or services into new business operations across the border, you need to consider tax rules related to transfer pricing. These rules apply to any business operating in two or more jurisdictions. Specifically, transfer pricing rules are intended to ensure that, if you and another entity within your group have transactions with each other, these transactions are priced as though the two parties are at arm’s length such that an appropriate profit is reported in Canada.
Choosing a transfer pricing policy that is appropriate for your business can be complex, especially for small- to mid-sized businesses exploring new jurisdictions for the first time. As transfer pricing guidance continues to evolve and tax authorities’ audit practices increase in sophistication, it’s prudent for companies to analyze their entire value chain and the impact of transactions on both jurisdictions when establishing a transfer pricing policy.
A multi-faceted approach
Companies expanding to a new jurisdiction with their valuable brands, technologies and/or software will typically require an intercompany license arrangement, and advisors will often recommend the comparable uncontrolled price (CUP) method as the most appropriate transfer pricing method to establish a transfer pricing policy, i.e., by identifying a royalty rate. Advisors may then undertake a benchmarking analysis to establish an arm’s length royalty rate; however, the analysis often stops there.
At this stage, companies may want to consider a more robust approach that assesses the expected impact of the royalty rate on the financial results. For example, a company could examine the financial forecasts of the new business to corroborate the above analyses and ensure that the new business expects to earn arm’s length profits in the longer-term post royalty payments. If such an analysis reveals that the new business would expect to have persistent start-up losses extending beyond what arm’s length parties may accept, the company should revisit whether the royalty rate indicated through the benchmarking analysis produces an arm’s length royalty rate under the circumstances.
Businesses don’t have to apply multiple transfer pricing methods to document their transfer prices, as the OECD’s guidance specifically states that the arm’s length principle doesn’t require the application of more than one method for a given transaction. However, the example above demonstrates how a multi-faceted approach may improve the quality of analysis, especially in the planning stages of your expansion. These considerations also have broader application beyond licensing arrangements and illustrate our approach when helping our clients establish new transfer pricing policies.
Examples of indicators that suggest additional transfer pricing considerations could be warranted when establishing new operations offshore include:
- new operations that expect to incur significant start-up costs
- new operations that expect to require a multi-year ramp-up period before reaching the desired operating capacity or sales levels
- the business involved generates an overall return that is significantly different from industry norms
We can help
Transfer pricing can be complex but with thoughtful analysis and advice, our award-winning transfer pricing team can help your organization establish or evaluate your transfer pricing policies so that they are pragmatic, defensible, and meet your organization’s objectives.
Contact one of our advisors today.