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Expansion is an exciting time for business owners, and a solid tax strategy is key to growth across the border. This episode explores the issues that can arise when Canadian companies set up business operations in foreign entities. In part two of this mini-series, BDO Tax Professionals Dan Lundenberg, Angeline Chandra and Daren Raoux guide us through these important steps.
Dan Lundenberg: Hi, I'm Dan Lundenberg. I'm a Tax Partner at BDO Canada and Leader for its U.S. Tax Service Line. And this is part two of our podcast on foreign expansion for Canadian companies. In part one, my BDO colleagues, Jill Birks and Gil Lederhos talked about the critical Canadian and U.S. tax issues Canadian companies face when expanding outside of Canada. In today's episode, we have Angeline Chandra, Tax Partner and Leader of the BDO Canada Transfer Pricing Group. Angeline will talk about the complex issues that arise when Canadian companies set up business operations in foreign entities. After Angeline, we have Daren Raoux from our Expatriate Tax Services Group. Daren will talk about the issues Canadian companies face when they send their employees to work outside of Canada. Let's start the conversation today with Angeline discussing the transfer pricing issues Canadian companies face with foreign subsidies.
Angeline Chandra: When a Canadian company is intending to expand his business outside of Canada, it is a very exciting time for business owners and management teams. I am sure that the first topic that pops into their minds is likely not transfer pricing. However, it is really important that companies realize the complexities of the transfer pricing rules in different countries, and that planning their tax strategies upfront can help mitigate any compliance or tax risks in the future. This will allow companies to focus more on their business operations and growth rather than spending valuable time and financial resources in fighting tax authorities and incurring non-compliance penalties.
Dan Lundenberg: Angeline, what problems can arise if transfer pricing compliance is complete in one country, but not complete in other countries?
Angeline Chandra: Every country has its own transfer pricing rules and requirements relating to compliance and administration of these rules. These rules can often contradict each other and there isn't always consistency between countries on how the transfer pricing rules are implemented. Before starting business in any country, it is crucial that a business owner understands the tax environment and the rules that would apply to them. I have often seen a situation where a company has a transfer pricing report prepared for one country, but not other countries. Every tax authority will not necessarily accept a Canadian transfer pricing report as being sufficient for their own country. And this can lead to tax reassessments and penalties for non-compliance. A tax reassessment unfortunately can result in double taxation in a case where a tax treaty does exist or does not allow for elimination of double taxation. So in today's economic environment, companies are really trying to preserve their cashflow and manage their expenses. Double taxation does not help cashflow for any business.
Dan Lundenberg: Angeline, what other issues should companies be thinking about when expanding outside of Canada? For example, when is the best time to think about putting together a transfer pricing policy?
Angeline Chandra: The first question that needs to be considered is whether the current transfer pricing model in place at the time of expansion makes sense given the business changes that may occur. It might make sense to realign the business functions, the business risks or asset investment of the multinational group. And understanding how the business units will operate going forward will have a direct impact on the amount of profits that will be taxed in each country, which in turn may impact the global tax rate for the multinational group. So for example, if a Canadian company is planning to set up a distribution center or a manufacturing facility in a foreign jurisdiction, what portion of global profits should be allocated to these business functions and would the local tax authority be satisfied with that allocation? Companies should also consider whether they would like to build capital or whether they will need to repatriate some of this capital to other countries. All of these issues can be addressed by establishing an appropriate transfer pricing policy upfront.
Dan Lundenberg: Angeline, what if a company does not already have a transfer pricing policy in place?
Angeline Chandra: Again, it is important that a proper transfer pricing policy be set up upfront to assist business owners with achieving their personal business and tax goals. For some business owners, their primary goal is to pay reasonable rates of tax on a global level. For other business owners, maybe building capital in a certain jurisdiction may be the most important factor. And to complicate things even more, in some businesses, the major value may be an investment in intellectual property. It's important for these types of companies, for example, ones that are operating in the technology industry, to understand that IP ownership from a legal versus tax perspective can be different. Appropriate transfer pricing model can help establish ownership in the country where the business owner wants the IP, rather than where a certain tax authority determines it should be owned. It's a matter of taking control of your business as an owner, rather than letting taxation issues drive the direction of your business.
Dan Lundenberg: Thanks Angeline. We're going to turn the conversation to Daren. Daren, what should be an employer's first steps when sending employees outside of Canada to work?
Sending Employees Across the Border Daren Raoux: Thanks, Dan. Well, it's a bit of a loaded question because I think there's a lot of issues for that employer to really think about. Obviously I like to think about the issues in kind of twofold. There's the employer side of it, which really starts off with things like immigration. What do I need to do to get that employee into the host country so that they can carry out their duties of employment? Maybe they're just going for meetings and a simple employer letter will suffice for the officials at the border. In other circumstances, a more formal work permit authorization may be required. And so it's obviously important to get to speak with immigration counsel early in the process so you don't have any unanticipated pitfalls as that employee tries to enter the host location. After that, once the employee starts to transition into duties of employment in that foreign location, then we start to open up issues like, payroll considerations.
I think for our listeners, it's important for them to understand that an employee will generally pay income tax where they physically work. It's not relevant necessarily where their payroll is delivered. So, for that Canadian employee, who's remaining on Canadian payroll, but working in another location, say for example, the United States, that employee will become taxable in many circumstances in the United States, and as a result the employer needs to think about pivoting the payroll process to take into account the necessary source deductions that either need to be redirected or added to on the U.S. side, to ensure that they are compliant as an employer from a tax compliance perspective in the host country.
In many cases our clients will introduce what we call a shadow payroll, which is essentially a process whereby the employee stays on home country payroll, but then in turn, the employer ensures that the necessary remittances are made on their behalf so that the necessary withholding taxes are paid in that host country.
And I think probably lastly, an important consideration for our employers is to really think about how do we create a tax efficient compensation package. You know, I think our listeners may or may not be aware that the typical foreign assignment for an employer can cost somewhere between two and five times the employee's base salary on an annual basis once you factor in all of the allowances, relocation costs, housing if it's provided by the employer. So there's certainly ways that a package can be structured on tax efficient basis to ensure that we keep costs as low as possible for that employer sending an employee across the border.
Dan Lundenberg: Thanks Daren. Who should lead the cross-border planning process? And this is a multiple choice question for you: the HR team, the tax team, the finance team, or the business line?
Daren Raoux: A bit of a trick question actually. I think you're missing an option that that would be any of the above. And I think it's fair to say that each organization's different and who may necessarily take the lead. I think if we think about all of the members making sure they're on the proverbial bus, so to speak, as long as the driver, and that may be the corporate tax team that is going to drive the initiative, as long as they look over their shoulder and make sure that we have someone like Angeline from transfer pricing, someone like Jill Birks as you heard from the last podcast from international corporate, as well as Gil on the bus, along with someone from HR, you'll get to where you need to go. And then as long as everybody's on the bus speaking and coordinating all of their efforts together, then that's really what's most critical. And as long as there's somebody, that quarterback, it should work out just fine.
Dan Lundenberg: Thanks. Thanks, Daren. And thanks Angeline for your thought-provoking discussion. I know that many business people think in terms of business lines and when these business lines cross border, transfer pricing comes into play to ensure that tax efficiency is optimized. Transfer pricing is also the shield against revenue hungry governments looking to be aggressive in tax audits. Issues raised by Daren have always been prominent for Canadian businesses that send their employees outside of Canada. And these issues will return to prominence when borders reopen later this year.
If you've enjoyed this podcast, please subscribe and tune in to the other episodes in this cross-border tax series. If you missed part one with Jill and Gil, please find it where you find your favorite podcast.
The information in this publication is current as of May 3, 2021.
This publication has been carefully prepared, but it has been written in general terms and should be seen as broad guidance only. The publication cannot be relied upon to cover specific situations and you should not act, or refrain from acting, upon the information contained therein without obtaining specific professional advice. Please contact BDO Canada LLP to discuss these matters in the context of your particular circumstances. BDO Canada LLP, its partners, employees and agents do not accept or assume any liability or duty of care for any loss arising from any action taken or not taken by anyone in reliance on the information in this publication or for any decision based on it.