On September 17, 2015, the Canadian Border Services Agency ("CBSA") released a revised D-Memorandum D13-4-5, "Transaction Value Method for Related Persons" (the "Memorandum"), addressing the impact of income tax transfer pricing on the value for duty to be declared on goods imported into Canada. This new guidance will have a significant impact on businesses involved in cross-border trade with parent companies, subsidiaries and other related entities as there are several important changes and clarifications to customs reporting, duty and accounting requirements regarding income tax transfer price adjustments, advance pricing arrangements ("APAs"), and transfer price agreements ("TPAs").
Transfer Price Adjustments – Fiscal Reporting Obligations
It has long been expected that the CBSA would take steps to address the reporting process for importers undergoing multiple transfer price adjustments within a single fiscal period. In its revised guidelines, the CBSA has further clarified at what point in time an importer is considered to have specific information giving "reason to believe" that a correction to its declaration of value is necessary pursuant to section 32.2 of the Customs Act. The Memorandum states that when an importer identifies the net total of upward and downward transfer price adjustments within an entire fiscal period, an obligation arises to submit to the CBSA a correction to its declared value for duty within 90 days.
Whether or not imported goods are subject to duties, section 32.2 of the Customs Act requires an importer to make such a correction where:
- the fiscal net total is determined to require an upward adjustment; or,
- the fiscal net total is determined to require a downward adjustment and the correction would be revenue neutral.
As described in D-Memorandum D11-6-6, "Reason to Believe", these adjustments must include any other post-importation changes made by the related parties to the purchase price paid or payable such as selling commissions or design fees. However, CBSA has stated it will scrutinize any such adjustments to ensure the adjustments would normally be included in the selling price of a comparable transaction between unrelated parties.
Significantly, the Memorandum notes that if an importer makes a post-importation, revenue neutral, downward correction pursuant to a pre-existing TPA, and if the imported goods were subject to duties, the importer may make a refund request using section 74 of the Customs Act.
Downward Price Adjustments Post-Importation – Refunds Allowed
The Memorandum addresses the issue of downward price adjustments raised in Customs Notice 15-001 and brings CBSA policy into accordance with Canadian International Trade Tribunal ("CITT") jurisprudence on the subject of the availability of refunds under section 74 and paragraph 48(5)(c) of the Customs Act.
Before the policy change effected by the Memorandum, CBSA's stated position was to impose additional duties on post-importation increases in purchase price paid or payable, while barring any refund on a post-importation decrease in purchase price paid or payable on the same goods. This approach was at odds with the CITT decision in Hudson's Bay Company v. President of the Canada Border Services Agency. The new approach, as adopted in the Memorandum, will also bring Canada in line with the approach to post-importation adjustments taken by customs authorities in the United States.
For this exemption to apply, the downward adjustment in transfer price must be a result of an agreement that was in writing and in effect prior to the importation. However, the Memorandum explicitly allows for the possibility that an unsigned agreement, which is otherwise treated as in effect between the parties, would be acceptable support for such a refund.
Transfer Price Agreements and Uninfluenced Price Determination
Under the Memorandum, where a TPA exists in a related-party importation, the transfer price set out in the TPA will be considered the "uninfluenced" price paid or payable for imported goods where the TPA is based upon accepted OECD methodologies or adequate supportive evidence. This approach to TPAs is consistent with the approach taken by the Canada Revenue Agency ("CRA") when examining TPAs for income tax purposes. However, for the purpose of customs valuation, for the price to continue to be considered "uninfluenced", any payments made to the vendor and any post-importation adjustments made to the purchase price must be declared to the CBSA along with the payment of any duties and Goods and Services Tax ("GST") owing.
While the CBSA notes that it will determine whether a TPA is in writing and in effect at the time of importation, CBSA will not necessarily preclude the use of a transfer price identified in a TPA if, at the time of importation, the TPA was not signed. This policy could broaden the scope of documents that may be used to establish "uninfluenced" price paid or payable.
In the Memorandum, CBSA expressly states that, in addition to signed and unsigned TPAs, transfer pricing studies and reports can validly form the basis for establishing price paid or payable between related parties. In regards to whether or not a document will qualify for such use, the CBSA has provided several criteria for assessing unsigned documents. In order for the CBSA to consider an unsigned TPA or other document, the Memorandum places onus on the importer to demonstrate that:
- the agreement existed at the time of importation;
- the agreement was effective at the time of importation; and,
- the value for duty was actually based on the unsigned but effective TPA.
This clarification acknowledges the central role that TPAs play in multinational intra-party transactions. The Memorandum also provides explicit recognition for the role of APAs negotiated with the CRA.
Advance Pricing Arrangements: New Recognition and Flexibility
APAs are agreements between customs authorities and importers that identify a mutually acceptable transfer pricing method for an importer's future specified international transactions. These agreements may be unilateral, bilateral, or multilateral and are negotiated between the taxpayer and domestic and international tax authorities. APAs are an invaluable method for reducing risk. A valid APA serves as an assurance that future transactions will be considered onside one or more income tax regimes by relevant domestic tax authorities (for example the CRA and the Internal Revenue Service in a Canadian-American supply),
The Memorandum increases the significance of such agreements for importers by declaring that the CBSA will now accept transfer prices set out in an APA as the price paid or payable for imported goods and, therefore, as the basis for their value for duty. Similar to TPAs, any post-importation adjustments made by an importer to transfer prices under an APA will likewise result in a requirement for the importer to make a correction to its declared value for duty and pay any duties or GST owing.
Regardless of whether an importer relies on a TPA, an APA, or an OECD method for pricing goods, all importers must exercise caution and recognize the difference between the purchase price paid or payable, which they may set, and the value for duty, which they are obligated to report. As with any importation, the purchase price paid or payable is subject to the adjustments required under the Customs Act including certain additional transportation costs, royalties and license fees, commissions, and subsequent proceeds.
The recent changes to the Memorandum present new opportunities for businesses importing products into Canada. Customs obligations arising from setting and adjusting transfer pricing and the payment of fees for management and administration as well as marketing and other services provided by related parties have a reputation for being rigourously enforced by the CBSA. Unwary businesses are frequently penalized for failing to account for transfer price adjustments and for improperly relying on their transfer pricing when making a declaration of value for duty.
The previous lack of certainty concerning the circumstances in which an importer was required to report adjustments to the price paid or payable for imported goods exposed businesses to the risk of significant reassessments of duties and GST and administrative monetary penalties and other fines. The Memorandum attempts to introduce more certainty regarding customs reporting and accounting requirements and confirms the existence of opportunities for businesses to claim refunds on transfer pricing adjustments as initially identified in Customs Notice 15-001.
This new guidance on the relationship between customs law and income tax transfer pricing also underscores the importance of ensuring that there are clear internal lines of communication among your organization's staff in the areas of trade compliance, finance, and accounting in order to address the significant risk exposure arising from the impact of transfer pricing and related party issues on your import obligations.
The International Trade and Investment Law Group at McCarthy Tétrault has considerable experience assisting clients with customs compliance and enforcement issues involving transfer pricing. We will continue to provide updates as CBSA's policy is implemented and evolves.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.