Issue 2025-01

In brief

An appreciation of the interplay between customs valuation and transfer pricing is crucial for Canadian businesses involved in cross‑border transactions with related parties. Businesses need to understand the distinct methods and objectives of Canadian customs and income tax authorities to help avoid adverse outcomes and ensure compliance with both direct and indirect tax requirements.

In detail

Background

The Canada Border Services Agency (CBSA) and the Canada Revenue Agency (CRA) use different methods to value intercompany cross-border transactions involving tangible goods. Customs authorities focus on ensuring that the value of imported goods accurately reflects all dutiable cost elements, while income tax authorities aim to ensure that the value is not misstated and accurately reflects income realized within their jurisdiction. These different goals can lead to competing tensions and incongruences that could negatively affect total tax liability outcomes.

Implications and considerations

Transaction value

The transaction value (TV) is the primary method used by the CBSA to value cross‑border transactions. Related party businesses must ensure that the TV declared for customs duty assessment purposes reflects the arm’s‑length principle set forth in the World Trade Organization (WTO) Valuation Agreement. This principle requires the price to be at arm’s‑length and that the relationship between the affiliated parties does not influence that price. Failure to demonstrate non‑influence will result in the inability to use the TV as the basis for the customs value.

The declared value of imported goods is a key driver for calculating the income taxes payable in the annual corporate income tax return for each jurisdiction. As the TV of tangible goods increases, the duty liability increases, which is the CBSA’s goal, but the profit of the buyer recognized for income tax purposes decreases, which is counter to the CRA’s preference.

Differences in applicable standards

There are significant differences between the principles of the WTO Valuation Agreement and the arm’s‑length standard principle used by Organisation for Economic Co‑operation and Development (OECD) member nations for transfer pricing purposes. The WTO Valuation Agreement focuses on examining comparable products and merchandise, while the OECD framework focuses on the functions and risks of parties to an intercompany transaction. This distinction arises because duties are assessed at the product level, whereas income taxes are assessed at the enterprise level. Canadian businesses should ensure that the substance of the method applied to their intercompany pricing formula supports the TV under customs rules.

Adjustments to transfer prices

Canadian businesses planning to make retroactive transfer pricing adjustments to align realized profit margins with the targeted arm’s‑length benchmark range have unique planning considerations for customs duty purposes. The Customs Act requires importers to amend the declared value within 90 days of having reason to believe the value was incorrect. The CBSA considers both upward and downward adjustments for customs valuation under the CBSA guidelines, provided the ability to retroactively reduce the transfer price is contemplated in an agreement that was in effect before importation.

In practice, this means that if there are changes to the transfer price after the goods have been imported, importers are obligated to report these adjustments to the CBSA. This includes both upward adjustments, which result in additional duties/taxes owed, and downward adjustments, when the decrease in value affects duty‑free goods (revenue neutral). For retroactive adjustments that reduce the declared value of dutiable goods, the importer is not required to report the change, but may do so to request a refund of overpaid duties (subject to CBSA consideration). Adjustments should be considered within the context of the importer’s responsibility to accurately report customs values and to pay any applicable duties/taxes owed.

In addition to adjustments to the transfer price, related parties should consider whether other intercompany charges (e.g. management and administrative fees or payments for research and development) should form part of the declared value, if they have not already been included. For details on these adjustments, refer to the CBSA’s Memorandum, D13‑4‑7 Adjustments to the Price Paid or Payable, August 29, 2013.

The takeaway

By understanding the interplay between customs valuation and transfer pricing, Canadian businesses can better navigate the complexities of international trade and tax compliance by:

• using a multidisciplinary approach to assess current transfer pricing models to manage total tax liability and required adjustment processes, particularly for customs duties and other indirect taxes
• ensuring proper documentation and compliance through:
  • evaluating policy and contract documentation from a customs duty perspective to ensure they reflect Canadian customs requirements
  • preparing contemporaneous documentation that fully covers the formula-pricing approach of the customs rules and aligns with the economic analysis in any transfer pricing studies or advance pricing arrangements (APAs)
  • reporting any changes in value to the CBSA, as required
• planning proactively, such as considering the use of APAs or other available transfer pricing dispute avoidance tools, ensuring your transfer pricing and customs compliance personnel communicate with each other, and keeping relevant tax and customs supporting documentation to facilitate compliance

Tax professionals should reach out to customs professionals when there are changes in transfer pricing policies or when preparing for customs audits. Identifying customs issues on tax documentation involves looking for discrepancies in declared values, ensuring alignment with arm’s-length principles, and verifying compliance with both customs and tax regulations.