Welcome to BDO Canada's Cross-Border Tax Podcast Series. This is the second of two episodes focusing on COVID-19. During our previous webcast, we discussed how the coronavirus pandemic has impacted cross-border taxation and the issues that many companies are facing when planning their future workforce.
In today's podcast episode, we are joined by Therese Garcia, who is a Partner with our Transfer Pricing team. And Bruce Goudy, a Director with our Indirect Tax Practice, who will discuss the challenges businesses are facing in providing services or moving goods between countries.
We'll start with Therese. What should businesses consider, from a transfer pricing perspective, when it comes to transferring goods to its related parties across the border? Transfer Pricing ChallengesTherese Garcia:
Thanks, Angeline. Let's be honest, COVID has made transfer pricing even more difficult, based on a combination of working with my clients and also the OECD's recent report on the transfer pricing implications of COVID, there are really three key themes or questions faced by companies that are transferring goods from its related parties across the border. And just to clarify, these transactions can be goods, as I mentioned, it can also be services, financing arrangements, or even the license of intangible goods. So, let's get to it. The first is that many businesses across the globe have incurred losses, but for transfer pricing purposes, the question becomes, which entities of a multinational group should bear the costs and losses incurred as a result of COVID? The second key theme is, governments globally have been generous in providing financial assistance to companies. How do we deal with these government incentives or assistance programs? And how should we treat them for transfer pricing purposes? And then finally, the third issue I've been seeing is, should the transfer pricing policy be revised by a multinational group? Should transfer pricing adjustments be implemented as a result of COVID? Angeline Chandra:
Therese, let's focus on the first theme you mentioned, how should companies deal with losses caused by COVID-19? Therese Garcia:
You know what, Angeline? That's a really good place to start. As a result of COVID, many multinational groups have incurred losses due to various factors, and this could be decreased demand, supply chain disruptions, and exceptional operating costs. The Pillars of transfer pricing and how to determine the profit and losses incurred by entities of a group is really based on the functions each entity performs, the risks born, and assets utilized. In order to support the allocation of costs or losses, companies will need to determine how the entities in the group respond to the heightened risks that really have arisen because of this pandemic, and really its subsequent effects on the transfer pricing of their transactions.
So, you might be thinking, well, what are these risks? These risks can be market, operational or financial risks. Given the pandemic, depending on the facts and circumstances, and the likely heightened risks born by routine entities, in essence, more risk means the entity may endure more costs, it allows for the possibility that a limited risk type entity performing routine functions may incur losses in the short term. So, hopefully, this gives some comfort to our listeners who engage in cross-border transactions, who have, or will experience a loss. Angeline Chandra:
Therese, going back to your point earlier, many companies are getting government assistance because they are experiencing financial hardship. What are your thoughts on how this impacts transfer pricing? Therese Garcia:
So, hopefully, many of our listeners have been successful in applying for and obtaining the Canada Emergency Wage Subsidy or other forms of government assistance. The CRA and many tax authorities globally, are of the view that government aid should not be shared, more specifically, the view is that the benefit of government assistance provided by the Canadian government should be retained by the Canadian taxpayer and remain in Canada. So, let me give you an example, in the case of intercompany services provided by a Canadian head office to its subsidiaries globally, and this is a very common theme, the costs incurred by the Canadian company in rendering services should not be reduced by the benefit of the wage subsidy under this approach. Bruce Goudy:
Hey Therese, from working with you in other clients' situations, I know you have a catchy three-step plan for your clients on how they can approach their transfer pricing challenges. Can I convince you to share that with us? Therese Garcia:
Thanks Bruce. So, I appreciate many businesses have other priorities besides transfer pricing, but I do recommend you revisit your transfer pricing, and this is consistent with the CRA's requirements of revisiting your transfer pricing on an annual basis and updating it. So, going back to Bruce's point, let me just share this with you all, that I almost keep top secret. It's a really simple three-step plan, and all you have to remember is the acronym DOTP or do TP. Super easy to remember, and the steps are straightforward and practical. So, D stands for, determine the impact of COVID. Review the impact of COVID, including any exceptional costs and losses, and document them. The O stands for, objectively consider the need for pricing adjustments, assess the current transactions, including contractual arrangements, and determine where pricing adjustments need to be made, based on existing policies.
And then finally, the TP, no, it doesn't stand for toilet paper, in this pandemic we're in, it stands for transfer pricing. And really, it's... A transfer pricing analysis and documentation needs to be updated and refreshed for the current year. You need to update the functional and risk profiles of the entities, ensure that the financial and contractual obligations are appropriately spelled out and are consistent with financial decisions that were made in the context of COVID. So, there it is, DOTP, do TP, three steps to ensure your transfer pricing is in order. Angeline Chandra:
Thanks for sharing your acronym with us, Therese. Now that we have heard about the transfer pricing implications of the movement of goods and services, Bruce will outline indirect tax considerations. Over to you, Bruce, Indirect Tax PerspectiveBruce Goudy:
Thanks, Angeline and Therese. And so, from an indirect tax perspective, now more than ever during the pandemic, businesses engaged in the cross-border buying and selling of goods into Canada need to review their arrangements with their customers, as well as your suppliers, to ensure that your inbound and outbound supply chain is tax efficient, both prospectively and, where possible, even retroactively. So, we encounter situations where businesses that ship goods to their customers in Canada, unknowingly incur hundreds of thousands of dollars of unnecessary costs arising from sales taxes, as well as duties, when their goods enter Canada. And in many cases, those costs are simply hidden along with their freight expenses, resulting in reduced margins, as well as cashflow burdens. So, if transactions are structured properly, though, those costs, especially from a GST perspective, should be reduced and perhaps even sometimes fully recovered. Angeline Chandra:
So, Bruce, in your experience, what types of arrangements between non-Canadian suppliers cause these unnecessary costs? Bruce Goudy:
Yeah, everyone is unique and to itself and has its own fact pattern. But the most common situation we see is where we have a vendor who's based outside Canada, hires a broker and acts as the importer of record to ship its goods to their customers into Canada. So, as an importer of record, that non-resident vendor is the party responsible for paying 5% GST on the value of the goods when they enter Canada, along with any customs duties. In a tax-efficient arrangement, that 5% GST should generally be fully recoverable by the importer, and not become part of their freight or cost of sales, but several things can affect whether that can be achieved and how that can actually be done. Therese Garcia:
Hey, Bruce, I spoke about the transfer of goods from a transfer pricing standpoint a bit earlier, what types of factors do companies need to consider, to ensure their supply chain is tax efficient? Bruce Goudy:
Good point, Therese. Now, I don't have anything catchy, like do TP, but it's more so, know your fact pattern for each of your shipments, when those goods are being shipped to Canada or coming into Canada. So, first of all, you need clarity on several things. One is where ownership and delivery of the goods actually occurs. It may not be in the same location for both. And you do that by looking at what are the terms and conditions stating, in that regard, in your purchase or your sale agreements. What incoterms are you referencing in your documentation? Who actually arranges the freight with a carrier? Which jurisdiction sale of goods act applies? And whether or not the business that's acting as the importer of record is actually registered for GST. So, once we have all that information, our guidance will actually vary based on those factors, and that will drive whether or not you have a planning opportunity to try to make your supply chain more tax efficient prospectively, or you might even be able to go back up to four years, to recover previously incurred costs. Angeline Chandra:
Bruce, I'm wondering, is the concern just sales tax, or do importers need to be concerned with customs duties? Bruce Goudy:
Yeah. And that's a good point. I did mention customs duties earlier too, at least sales tax, it should be structured so that, that's always recoverable. If you do have to incur duties, then that generally represents a cost. However, what you need to look at, importers should be concerned that if they are paying duties, is there a way that they can reduce those duties by considering, do they have the right tariff classification? Or perhaps, is there a favorable treatment under USMCA or CUSMA or the European CETA Trade Agreement that could actually allow for reduced tariffs. Angeline Chandra:
What about on the purchasing side? For example, where a non-Canadian business is buying goods from a Canadian supplier. Bruce Goudy:
Yeah. So, if goods are being sold to a non-resident, as opposed to goods coming into Canada, two situations come to mind. The first one is where we have goods that are actually exported from Canada to, perhaps the U.S., or elsewhere. In that case, the foreign customer should generally not be paying GST to the Canadian vendor. And that's the Canadian vendor generally needs to make sure that it's got proof that those goods are actually exported. And then the second example is where you might have a Canadian vendor that is selling to a non-resident of Canada, but the non-resident of Canada says, "Can you deliver that to my customer in Canada?" And because once those goods are delivered at a destination in Canada, tax would normally apply. And so, where we have those situations, the non-resident is generally not able to recover that tax if it has been charged, especially if it's not registered for GST. In that case, there's a system of drop shipment certificates that actually provides relief for that non-resident, and those are common situations that we see. Angeline Chandra:
Thanks, Bruce and Therese. That was very helpful, and just the tip of the iceberg, in terms of the indirect tax and transfer pricing considerations for the transfer of goods across the border during COVID-19. To summarize what we shared today, on the indirect tax side first, know whether you are paying GST in duties on your imports into Canada. Second, if you are paying tax, know whether you're recovering it. And third, plan and recover for a tax efficient supply chain. And for transfer pricing, first, if you have incurred losses, determine how this impacts your transfer pricing. Second, consider the need for transfer pricing adjustments. And third, transfer pricing analysis and documentation needs to be updated and refreshed for the current year.
In case you missed the first episode of this two-part mini-series
, we had Laura Ball from our International Tax Practice, Joanne Sun from our Expatriate and Immigration Tax Practice, and Kareen Tea from our U.S. Tax Practice, share their thoughts on cross-border tax and how COVID-19 has impacted many companies' plans on the future of their workforce. If you wish to speak with us about the topics discussed on today's episode, please reach out to any of us. As well, please subscribe and follow our cross-border tax podcast series. Thanks, and have a nice day.