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The following is a great post that we thought deserved special attention.  It looks at transfer pricing.  Not only are ordinary Canadians being cheated, so is Revenue Canada.  

Thanks to Nahanni  for the post.

Here is a thought that I have not yet seen discussed on any blog and it deals with the possible violation by BMW Canada of the Transfer Pricing Rules in section 247 of the Income Tax Act (Canada).

BMW Canada buys its cars from its foreign corporate parent (Bayerische Motoren Werke AG, which I will call “BMW Germany” for short). (A similar buying structure would apply to other Canadian subsidiaries of foreign car manufacturers.) Similarly, BMW of North America also buys its cars from its foreign corporate parent (BMW Germany).

The following illustrates the wholesale dealer pricing differential between Canadian and US marketed BMWs. For a 2008 BMW 650 coupe (base car, no options), the wholesale price to the Canadian dealer from BMW Canada appears to be in the range of $92,000 (with a retail price to the public of $101,500. However, in the US wholesale price to a US dealer appears to be about $67,000 (with a retail price to the public of about $75,600). No doubt, these wholesale prices are the direct result of the pricing agreements that each of BMW Canada and BMW of NA have their corporate parent (BMW Germany).

Section 247 of the Income Tax Act (Canada) relates specifically to transactions or arrangements between a taxpayer (such as BMW Canada) and a non-resident person with whom the taxpayer does not deal at arm’s length (BMW Germany). The transfer prices adopted by a group of non-arm’s length parties (such as between BMW Germany and BMW Canada) directly affect the profits to be reported by each of those parties in their respective countries. Canada’s transfer pricing legislation embodies the arm’s length principle and requires that, for tax purposes, the terms and conditions agreed to between non-arm’s length parties (BMW Canada and BMW Germany) in their commercial or financial relations be those that one would have expected had the parties been dealing with each other at arm’s length.

In effect, if BMW Canada were buying a new BMW 650 from BMW Germany for the same price as BMW of NA pays (which is probably about $25,000 less than it now pays), then on the sale of the vehicle for $101,500, the profit recorded by BMW Canada would be $25,000 higher. Instead, that $25,000 of extra income is reported and taxed in Germany in the hands of BMW Germany and is not taxed in Canada. Hence, the Canada Revenue Agency (formerly Revenue Canada) is receiving tax on about $25,000 less income on the sale of the BMW 650 in Canada (which at a 35% tax rate is about $9,000 less tax than it may be entitled to receive) than if BMW Canada were paying the same or similar price to BMW Germany as BMW of NA pays to BMW Germany.

The transfer pricing rules allow the Canada Revenue Agency to treat BMW Canada’s cost of the vehicle as the lower amount (even thought it pays the higher amount), thereby increasing the income taxed in Canada by $25,000.

In other words, I believe that the Canada Revenue Agency should begin an audit of the income tax reporting of BMW Canada (as well as the other Canadian marketing subsidiaries of foreign vehicle manufacturers) to ensure that if these cross border pricing discrepancies continue, Canada gets its fair share of income tax tax from each sale.

The transfer pricing rules in Canada are designed to ensure that Canadian taxpayers (such as BMW Canada), who are non-arm’s length members of a group and engage in transactions with a non-resident member of that group (such as BMW Germany), report substantially the same amount of income as they would if they had been dealing with each other at arm’s length.

Section 247 of the Income Tax Act also contains penalty provisions where the transfer pricing rules are violated. These penalties can be substantial.

At the end of the day, the real cause of the higher Canadian vehicle prices is the pricing regime set by the foreign parent manufactures when selling their cars to their Canadian subsidiaries. I sympathize with the Canadian dealers, who are caught in the middle and are forced to sell their cars at prices higher than their dealer costs, or lose money themselves on each sale. I would much prefer to purchase from a Canadian dealer, but in order for that to happen,Canadian dealers must be able to buy their cars at wholesale prices which are competitive with US dealer costs. The system would then balance out and Canadians would get the benefit of their higher Canadian dollar.

If “jobs” are being lost in Canada because of Canadians buying cars in the US, it is the direct result of the foreign car manufacturers inflating their prices to their Canadian subsidiaries, contrary to the transfer pricing rules discussed above, not ordinary Canadians trying to save money on one the largest purchases that they will make in a year. If the impediments to importing US sourced vehicles were eliminated (by such things as standardizing Canadian vehicle requirements with those in the US), the flood of imported cars from the US would VERY VERY quickly cause the foreign manufacturers to lower their prices to their Canadian subsidiaries to be competitive with these US prices. People would then STOP buying cars in the US and would resume buying in Canada. The result would be lower vehicle prices in Canada and a considerable drop in the Canadian inflation rate.

To me, our Canadian federal government must take the bull by the horns and deal with this in a fair and equitable way immediately. This should include the IMMEDIATE removal of the provisions added on November 26, 2007 which give BMW Canada the right to determine the admissibility of BMWs coming into Canada (along with the “roadblocks” its unreasonable fees and unnecessary vehicle modifications which it is now imposing). BMW Canada is the party which most wants to stop the import of US sourced BMWs into Canada and to give it control of the process of admitting such BMWs into Canada is a direct and flagrant CONFLICT OF INTEREST. “It is the same as putting the fox in charge of protecting the chicken coupe.”

Similar changes should also be made IMMEDIATELY to the same rules which give other Canadian subsidiaries of foreign vehicle manufacturers the right to do the same (e.g. Mercedes Benz).

Thank you for your interest in this subject, as the sooner that it is corrected the better off ALL Canadians will be. All of this is a sad reflection on the vehicle sales process in Canada and how ordinary Canadians are being cheated by the big foreign vehicle manufacturers.