Over the past few decades, Canadian and US companies have developed close commercial interdependence, characterized by integrated supply chains and joint operations. However, increased tariffs and growing geopolitical uncertainty have put significant pressure on these structures. In this context, the tax implications, both in terms of transfer pricing and customs valuation, have become a key issue that companies must address comprehensively.
Transfer pricing and customs value
The arm’s length principle, enshrined in Section 482 of the US Internal Revenue Code (IRC) and Section 247 of Canada’s Income Tax Act (ITA), establishes that transactions between related parties must reflect market conditions. Faced with a complex tariff environment, some companies may be inclined to place transfer prices within the acceptable range, but at the lower end, in order to reduce the tariff calculation base. However, this approach is not always accepted by customs authorities, requiring coordinated analysis between customs valuation and transfer pricing specialists.
Methodologies and comparability
The imposition of tariffs is an external economic variable that can directly influence transfer pricing comparability studies. This requires updating benchmark analyses to accurately reflect the effects of tariffs on uncontrolled transactions. Tax and customs authorities often carefully examine these adjustments, so it is essential to have technically sound and well-documented studies.
Documentation and compliance
In both the US and Canada, companies must maintain up-to-date documentation justifying how tariffs affect prices between related parties. This includes analyzing comparables, determining which party bears the cost of the tariff in an arm’s length transaction, and clauses in intercompany contracts that allocate this risk.
In addition, it is essential to consider the differences between customs values and values for tax purposes. For example, certain cost elements (commissions, interest, or packaging) may be excluded from customs value but included in the transfer pricing base. This bifurcation must be clearly documented to avoid noncompliance.
Economic effects and subsequent adjustments
In some cases, companies may need to make retroactive adjustments to transfer prices to keep profit margins within acceptable ranges for tax authorities. However, an upward adjustment may involve additional customs duties, while a downward adjustment will only give rise to refunds if strict conditions are met prior to importation.
The redistribution of profits within the global value chain also creates risks: if profits decline due to tariffs, the entities affected must be correctly identified, and the consequences documented based on the risk allocation pre-established in intercompany contracts.
Tax penalties and risk exposure
Changes in intercompany prices driven by tariff considerations may increase the risk of penalties. In the US, for example, an understatement of income that is not properly documented can result in penalties of up to 20% under Section 6662 of the IRC.
In Canada, the ITA establishes a 10% penalty on the net transfer pricing adjustment when reasonable documentation requirements are not met.
Inventories and tax valuation
Tariffs directly influence inventory valuation. In Canada, the lower of cost (including tariffs) and fair market value is used. If tariffs raise the acquisition cost without a proportional increase in market value, this may result in tax deductions for devaluation.
In the US, using the LIFO method can be a strategy to mitigate the impact of increased costs; however, its application involves strict accounting requirements, including a minimum duration of five years.
Indirect implications and trade agreements
Although tariffs are not income taxes and do not qualify as foreign tax credits, they do affect profitability, cash flow, and the ability to claim certain tax benefits.
Trade agreements such as CUSMA (T-MEC in Mexico, USMCA in the US) may offer certain protections, although they do not necessarily eliminate tariffs derived from regulations such as Section 232, Section 301, or the IEEPA. There are also dispute resolution mechanisms (such as Chapter 31 of CUSMA or WTO panels), although their effectiveness has been questioned due to dysfunctionalities such as the suspension of the WTO Appellate Body.
Government support
The Canadian government has implemented support measures for companies affected by tariffs, including financing programs, special loans, and temporary tax relief (such as GST/HST deferrals and corporate tax payments).
The US, for its part, is considering tariff exemptions for critical or locally unavailable goods, although these are under constant review. The de minimis regime (exemption for products under USD 800) remains in place but faces legislative proposals for its elimination.
Reorganization of operations
Companies should consider restructuring their supply chains or relocating operations. For example, establishing a subsidiary in the US to serve that market directly could have significant tax implications, such as the creation of permanent establishments or the application of the branch profits tax. Likewise, from a customs perspective, the country of origin of the goods—and not just the place of assembly—will determine the applicability of the tariff.
Conclusion
The interaction between transfer pricing, customs valuation, and tariff regimes represents a significant challenge for companies with cross-border operations between Canada and the US. Faced with a more protectionist global environment, companies must adopt a proactive approach, coordinating tax, contractual, and logistical aspects. Timely review of documentation, intercompany contracts, and pricing policies will be critical not only for regulatory compliance but also for financial sustainability in the face of new trade challenges.
Source: CPA Canada