Canada depends on being an open economy in order to prosper. Its economic development has been based on trade and foreign direct investment, both inward and outward. Indeed, as economic research shows, trade and FDI are inseparably linked.11 As stated earlier, foreign direct investment strengthens the growth potential of the host country by importing knowledge and technologies from global corporations to the subsidiary with spillovers to other domestic firms. It also creates new trade opportunities as the foreign-owned subsidiaries export their products and services to other parts of the global company or to foreign markets.
| About Transfer Pricing What Is Transfer Pricing? "Transfer prices are the prices at which an enterprise transfers physical goods and intangible property or provides services to associated enterprises."1 The types of transactions can include administrative or management services, royalties, goods for resale, goods for production, financing transactions (loans between related parties) and technical services. Why Is Transfer Pricing an Issue for Tax Administration? Tax administrations throughout the world are concerned about transfer pricing because this price determines the income and expenses associated with multinational activities, and thus the taxable profits of not-at-arm's-length corporations in different tax jurisdictions. Inflated transfer prices can have a detrimental impact on a jurisdiction's corporate tax base. How Is Transfer Pricing Addressed? Over the last few decades, virtually every tax jurisdiction in the world, including Canada and the United States, has enacted detailed requirements and systems of checks and balances with respect to transfer pricing, with severe penalties (particularly in the United States) for corporations found to be avoiding tax through excessive transfer pricing. In 1992, the United States enacted new transfer pricing legislation, which contained stringent documentation requirements and penalties for failure to provide adequate documentation about a corporation's transfer pricing mechanisms. Canada quickly followed suit, introducing an Advance Pricing Arrangement (APA) program in 1993 and revising the transfer pricing legislation in 1998. Tax departments in most jurisdictions address the issue by requiring firms to use commercially verifiable prices as the basis for their inter-company transfer prices. In practice, many transfers involve goods or services that are not sold commercially. When this occurs, tax authorities look for a reasonable approach behind the pricing used. The actual calculation varies from country to country, and each calculation is governed by the respective bilateral tax treaties. In principle, the treaties are meant to ensure that transfer prices reflect the underlying costs and economic valuations being transferred between related corporations. 1 OECD, Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (Paris: OECD, 1995), p. P-1. Source: The Conference Board of Canada. |
Canadian direct investment abroad has grown substantially over the last decade, and Canada is enjoying its benefits.12 However, growth in inward foreign direct investment has not been as strong, and Canada is losing its share of global and North American FDI stock. Canada needs to have strong two-way direct investment flows in order to improve its competitiveness and its economic potential.
The remainder of this report attempts to answer two key questions: Why is Canada less attractive to foreign investors than it used to be? How do senior executives in foreign global companies perceive Canada as a place to invest?
12 For example, the value of royalties and licence fees from service exports increased more than fivefold between 1995 and 2002. Industry Canada, Trade and Investment Monitor 2003, p. 34.