Written by: Paul J. Leedham
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As emerging technology companies begin to establish their presence in the domestic marketplace, considerations often turn to what kinds of opportunities could be capitalized on by venturing into international markets.
Entrepreneurs may want to expand their global footprint in order to facilitate a more cost effective product conversion process and/or to take advantage of sales opportunities available in other geographical regions where market demand exists. When doing business internationally, there are a number of things that entrepreneurs need to be mindful of, including the requirement to have appropriate transfer pricing policies in place.
Transfer prices are those prices at which services, tangible property, and intangible property are traded across international borders between related parties. The concept of transfer pricing becomes an area that can form an important part of an emerging technology company’s tax compliance requirements when related entities are operating in multiple jurisdictions. For example, an entity may purchase goods or services from one of its international subsidiaries for a specified amount of consideration (the transfer price). Given the parent and subsidiary are related parties they are not considered to deal at arm’s length with one another and, as a result, the transaction price between these entities may not be representative of what unrelated, arm’s length parties would have transacted at in an uncontrolled market.
In another example, an entity may have established an operating subsidiary in another country and subsequently transfers intangible property, such as the right to use a brand name, to this subsidiary. From a business perspective, the transferring entity (transferor) will desire to recover the development and other costs involved with creating the intangible property as well as earn a reasonable return. The receiving entity (transferee) naturally expects that acquiring the right to use this brand name will help contribute to its ability to generate larger profits. In each of these separate situations, as the parent and its subsidiary are based in different countries and hence, different tax jurisdictions, the applicable transfer pricing is susceptible to challenge by the respective taxation authorities and adjustments might be required if it is not thought to be reasonable in the circumstances.
Of concern to the taxation authorities is whether profits are being inappropriately diverted from the local tax jurisdiction, particularly where profits are perceived to have been moved out of one tax jurisdiction into another where tax rates are comparatively more favourable. Companies are required to properly document their transfer pricing policies in order to support that transactions between related entities have been conducted with reference to terms and conditions that would be evident if such parties were instead dealing at arm’s length. While the Canada Revenue Agency (“CRA”) has published guidelines on the specific transfer pricing documentation that companies are required to have in place in order to support the appropriateness of transfer prices used, the determination of such can still be fairly subjective. This documentation must be in place within prescribed timelines and failure to provide evidence of such to the CRA in a timely manner should it be requested can result in significant penalties for the entity. Adding to the complexity of things is that entities must satisfy the particular transfer pricing requirements of both the domestic and foreign tax jurisdictions they are operating in.
When entrepreneurs decide to expand the operations of their emerging technology companies into international markets, it can open the door to new business opportunities and even help streamline costs. However, it is important to be aware of and understand the relevant business risks of operating across international borders especially in regards to transfer pricing. This will help to ensure maximum chance of success for not only establishing the entity’s presence globally but maintaining and growing it over the long term.
Please contact Paul J. Leedham, CPA, CA, CGA at 604-714-3685 if you have any questions about this post
The above content is believed to be accurate as of the date of posting. Canadian Tax laws are complex and are subject to frequent changes. Professional tax advice should be sought before implementing any tax planning. Manning Elliott LLP cannot accept any liability for the tax consequences that may result from acting based on the information contained therein.