Over the last decades, Canadian and US companies have built close commercial interdependence, including integrated supply chains and joint operations. Conversely, increasing tariffs and geopolitical uncertainty have significantly pressured these structures. In this context, 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 Valuation
The Arm’s Length Principle, stipulated in Section 482 of the US Internal Revenue Code (IRC) and Section 247 of Canada’s Income Tax Act (ITA), establishes that related party transactions must reflect market conditions. Before complex tariffs, some companies may be tempted to place transferred prices within the acceptable range, but at the lower end, to reduce the tariff calculation basis. Conversely, 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 factor that directly impacts Transfer Pricing comparability studies. It necessitates updating benchmark analyses to account accurately for the effects of tariffs on uncontrolled transactions. Tax and customs authorities often scrutinize these adjustments, so technically sound and properly documented studies are crucial.
Documentation and Compliance
In both the US and Canada, companies must maintain current documentation that supports how tariffs affect related-party pricing, thus analyzing comparables, determining which party bears the cost of the tariff in an independent transaction, and clauses in intercompany contracts that distribute this risk.
Additionally, the differences between customs values and values for tax purposes are fundamental. 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 non-compliance.
Economic Effects and Subsequent Adjustments
In some cases, companies may need to retroactively adjust transferred prices to keep profit margins within ranges acceptable to tax authorities. Conversely, an upward adjustment may entail additional customs duties; otherwise, it will only result in refunds if strict conditions are met before importation.
The reallocation of profits within the global value chain also creates risks: if profits decrease due to tariffs, the affected entities must be correctly identified, and the consequences reported based on the risk allocation pre-established in intercompany contracts.
Tax Penalties and Risk Exposure
Intercompany price changes driven by tariff considerations may result in penalties. In the US, for example, an understatement of income improperly reported can result in sanctions of up to 20% under Section 6662 of the corporate income tax. In Canada, the ITA establishes a 10% penalty on the net Transfer Pricing adjustment for non-compliance with reasonable documentation requirements.
Inventories and Tax Valuation
Tariffs directly influence inventory valuation. Canada applies the lower of cost (including tariffs) and fair market value. If tariffs increase the acquisition cost without a proportional increase in market value, it may result in tax deductions for devaluation.
In the US, using the LIFO (Last In, First Out) method can be a strategy to mitigate the impact of increased costs. Conversely, 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 and USMCA in the US), may offer certain protections. Conversely, they do not necessarily eliminate tariffs derived from regulations such as Section 232, Section 301, or the International Emergency Economic Powers Act (IEEPA). There are also dispute resolution mechanisms (such as Chapter 31 of CUSMA or WTO panels); however, their effectiveness has been questioned due to dysfunctions 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 constantly reviewed. The de minimis regime (exemption for products under USD 800) remains in force, but faces legislative proposals for its elimination.
Operational Reorganization
Companies should consider restructuring their supply chains or relocating operations. For example, establishing a subsidiary in the US to directly serve that market could have significant tax implications, such as the creation of permanent premises or the application of 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 regimes, customs valuation, and tariff rates represents a significant challenge for companies with cross-border operations between Canada and the US. Companies should adopt a proactive approach, coordinating tax, contractual, and logistical aspects in a more protectionist global environment. Prompt review of documentation, intercompany contracts, and pricing policies will be crucial not only for regulatory compliance but also for financial sustainability amid new business challenges.
Source: CPA Canada