Price points and pressure points: multinationals’ transfer pricing in practice during a time of uncertainty

Siwei Chen

Borden Ladner Gervais, Calgary
SChen@blg.com
 

Protectionist policies, such as those currently implemented by the United States, are posing a threat to global trade and businesses more broadly, especially those that have traditionally thrived on interconnected global supply chains.

Historically, multinational companies have made operational decisions based primarily on strategic and commercial objectives, with tax professionals later reviewing and refining the resulting structures to ensure tax efficiency. But as major economies, including the US, introduce tariffs and other trade measures, transfer pricing is taking on a more prominent role in shaping business decisions. Although it may not be the central factor, it is becoming an influential consideration in corporate strategy, particularly in regard to a shifting geopolitical landscape.

Primary considerations for multinationals

Within this context of geopolitical change, some of the key considerations for multinational businesses are outlined below:

• risk assessment: recent geopolitical tensions require businesses to assess their risk tolerances and determine the best course of action. Companies must assess whether their strategic goals are better served by minor, short-term changes or more substantial, long-term structural adjustments. Using data analytics and scenario modelling can provide valuable insights to support these decisions. An important factor in this evaluation is identifying which entity within the organisation will bear the tariff costs;
• short-term changes: multinational companies should undertake a fresh transfer pricing analysis to evaluate potential adjustments to their intercompany pricing approach. This may be necessary due to shifts in their business or industry, modifications to intra-group legal agreements, or the pursuit of advance pricing arrangements (APAs); and
• long-term structural adjustments: for more long-term solutions, entities may reconsider and re-evaluate supply chain operations, the terms and conditions in intercompany agreements and the allocation of organisational risks to ensure that these risks are more effectively distributed within a multinational corporate structure. Furthermore, businesses may look into opportunities to reorganise their corporate operations, which could involve relocating manufacturing or business units, as well as reviewing and potentially redistributing functions and risks more broadly.

Background

Multinational companies operate within intricate global supply chains, where transactions involving goods, services or intellectual property between affiliated entities are governed by transfer pricing. These pricing mechanisms influence both income tax distribution and business strategy, while governments closely monitor them to curb tax avoidance. This article examines how multinational corporations can mitigate risk and diversify their internal supply chains in response to economic uncertainty, as well as the role transfer pricing plays in shaping these decisions.

The relationship between tariffs and transfer pricing

Despite transfer pricing and tariffs being separate legal areas, the former can impact the cost base for tariffs and, thereby, influence the amount of tariffs that are payable. Increased information sharing also facilitates cooperation between tax authorities and border agencies to ensure alignment in regard to reported values. If a tax authority adjusts the transfer prices reported by a taxpayer, this may prompt a review by border agencies with respect to tariffs. Deliberately lowering transfer prices to reduce tariffs could lead to increased regulatory scrutiny and tax re-assessments.

Current uncertainties

The unpredictability surrounding US trade policy is expected to persist. Even if tariffs are removed, they may re-emerge as a negotiation tactic in the future. Companies need to weigh the risks of making significant capital investments now (eg, such as relocating functions and risks) against the possibility that tariffs could be lifted in the near term. Alternatively, delaying major structural changes in favour of smaller, incremental adjustments may pose challenges if the tariffs remain in place for an extended period. To navigate this uncertainty, businesses should assess their risk tolerance and use scenario modelling to evaluate potential strategic responses.

Navigating difficult decisions in a shifting business landscape

Given the evolving policy environment, businesses should implement changes gradually. A cautious strategy would involve starting with small adjustments to manage risk, while conducting thorough studies and modelling exercises to assess the long-term viability of diversification and de-risking strategies. As new information becomes available, these studies should be updated regularly to include new factors, helping to guide well-informed decisions.

Advice for businesses

Tariffs (so far) do not apply to services and intangibles

As currently contemplated, the tariffs and retaliatory tariffs being imposed generally apply to tangible goods. As such, businesses that exclusively deal with services and intangibles do not need to revise their intercompany transfer pricing arrangements. That said, such businesses should remain vigilant as the focus on tangible goods could quickly shift to the provision of services and intangibles.

In addition, issues are likely to arise for multinational business anyway because their operations generally include both tangible goods and the integration of services and intangibles, making it challenging to separate these elements in practice. As adjustments are made to supply chains, the management of these components may also need to be reconsidered.

Mitigating tariff costs with short-term strategies

In the short term, businesses should assess their goods that cross the Canada–US border and determine whether they can legally reduce the cost base for such goods.

If there have been notable changes in the business or manufacturing operations of an organisation, or if a transfer pricing study has not been completed recently, conducting a new study may be necessary. Companies could consider adjusting their pricing methods within the bounds of the arm’s length principle, although this could increase the risk of an audit. The arm’s length standard must still be applied in regard to tariff-affected transactions and businesses must determine how to allocate the tariff costs between the involved parties. Companies should also assess their current intercompany agreements to see whether they need to be updated in order to allocate tariffs properly and adjust pricing. In the event any such changes are reviewed by way of an audit, organisations should ensure that all changes are carefully and diligently documented as they occur.

As a result of the recency and uncertainty surrounding tariffs, there is an absence of administrative guidance as to who should bear the cost of tariffs from a transfer pricing standpoint. Given this uncertainty, Canadian subsidiaries of multinational companies transacting with US affiliates may want to consider applying for a bilateral advance pricing arrangement (BAPA), involving both the Canada Revenue Agency and the US Internal Revenue Service. This will provide a level of certainty that the agreed-upon prices are likely acceptable to both tax authorities.

To mitigate against the costs associated with making significant structural changes, businesses should explore efficiency gains within their existing supply chains. For instance, they could minimise the number of border crossings for a product or separate raw materials from value-added services, allowing raw materials to cross the border, while value-added services are provided afterwards.

Tariff proofing (to an extent) with long-term strategies

In the current geopolitical climate, assessing tariff risk should be an ongoing priority. Even if the current US tariffs are removed, it would not eliminate the possibility of new ones being imposed by the US or other nations. As such, businesses should keep assessing supply chain diversification to reduce future risks. For instance, at the risk of tax audits and potential exit taxes, companies may consider relocating their manufacturing activities to the US to better serve American customers, duplicating these operations in other countries to avoid potential retaliatory tariffs, or even consider exiting the US market entirely.

Protectionist policies around the world are on the rise and, as a result, we see an increase in tariff-related uncertainties. Companies should assess potential structural changes to broaden their geographical presence and consider adjustments to their transfer pricing strategies to better distribute risk across their corporate framework. This highlights the importance of doing business with companies in countries that have trade agreements with Canada that are reliably upheld.

This strategy will enable businesses to stay agile in response to shifting trade policies, while building long-term adaptability.