For multinationals with branches in both Canada and the United States, there’s one big tax challenge that’s impossible to ignore: U.S. tax rates are generally higher than Canadian tax rates. Companies wrestling with this issue are always looking for ways to reduce U.S. income and maximize Canadian income (within the existing rules), lowering their overall tax burden. Some strategies include financing, transfer pricing, inter-company charges, and reducing tax liability through tax planning. To make the most of these options, it’s important to take the following steps.

Take advantage of deduction options

Are your accounting, HR and legal departments all based in Canada? If part of their work is for the U.S. operation, you can charge that to your U.S. subsidiary and get a deduction in the U.S. If this is taxed at 40% in the U.S., but only 28% in Canada, that’s a lot of tax savings. The same thing happens with interest when you loan funds to the U.S. side of your business and they pay interest to the Canadian side: they get a deduction at 40%.

Get to know the interest rules

The interest rules for multinationals are extremely complex. You have to (a) get a loan to qualify as a loan from a U.S. tax perspective and (b) make sure that the interest payments made from the U.S. to Canada are deductible in the U.S. Earnings stripping rules are in place to prevent foreign companies from over-leveraging their U.S. subsidiaries, so you have to be careful when navigating the rules. Otherwise, there’s a risk you might go overboard.

Always plan ahead

When planning your loan strategy, you have to make sure your U.S. subsidiary has the cash flow to make interest payments in accordance with the terms. If you don’t make these payments, you won’t get the deduction. It’s also worth noting that this is an area of heightened scrutiny. In fact, the IRS just recently finalized new regulations dealing with what qualifies as a bona fide loan.

Stay at arm’s length

There are rules in both Canada and the U.S. regarding inter-company charges – for your back office charges, HR, accounting, legal and executive compensation. There are also transfer pricing rules that make sure the rate being charged is an arm’s length rate, not an excessive rate. You can’t charge more to your subsidiary than you’d charge to someone else, just because you want to get a deduction in the U.S.

Documenting your rates

If challenged by the IRS, you need to have documentation for your transfer pricing from the time it was put in place. You need to show (a) what the policy is, (b) the formula for determining the cost and (c) your basis for saying it is arm’s length. It is always wise to ensure that this is done from the start – don’t wait until there’s a question from the IRS.

Jim McEvoy, CPA (New York), has two decades of U.S. tax experience. His areas of expertise include cross border tax, financing and leasing structures, U.S. individual and estate tax as well as U.S. real estate investments.