Sam systems Inc. (SI) is a Canadian-controlled private corporation and a leading edge developer and manufacturer of furniture components with subsidiaries worldwide. You are the tax manager for SI. The controller of the corporation is very concerned that the corporation's intercompany transactions do not meet the transfer pricing requirements of the Act. In a recent meeting, the controller provided you with the following information concerning the company's transactions with foreign corporations.
Transactions with Sam systems Netherlands Inc. (SNI)
SI sells metal drawer slides to its newly acquired, wholly owned subsidiary, SNI. SNI was acquired by SI in July and has two divisions: a manufacturing division that manufactures ergonomically designed furniture components, and a distribution division that distributes curtain rod products purchased from Thailand and now drawer slides purchased from SI, as well. All products purchased by the distribution division are sold to arm's length European distributors.
Until the purchase of SNI, SI was selling drawer slides directly to European distributors for all European sales. Now all European sales are through SNI. Over the next two years, SNI plans to replace the use of distributors in the European market and sell SI's slides directly to original equipment manufacturers. SNI does not own any trademarks related to the sale of SI products. SNI is responsible for collection of receivables from European distributors. However, SI is responsible for all warranty costs associated with the sale of its products by SNI. All patents for Canadian-manufactured products are owned by SI.
For Canadian sales, SI sells drawer slides to arm's length distributors in Canada. All international sales of the slides are sold by subsidiaries of SI (including SNI) in various countries.
A subsidiary of SI, Sam systems United States Inc. (SUSI) (see below), manufactures a similar drawer slide to SI's. These slides are sold by the U.S. company to arm's length distributors in the U.S. market.
For its taxation year ending December 31, SNI's distributor division earned a gross margin of 30% and an operating profit of 5% of sales for its sales of SI product. For sales of curtain rods, the division earned a gross margin percentage of 35% and an operating profit of 8% of sales.
Transactions with SUSI
SUSI was acquired by SI through a share purchase in July. For several years prior to the acquisition, SUSI had purchased ergonomic furniture components from SI for distribution to original equipment manufacturers in the U.S. After the acquisition of SUSI, SI continued to sell these products to the company. SUSI does not own any trademarks for the sale of SI's product and does not distribute products for any other entity. SI sells its ergonomic products in Canada through arm's length Canadian distribution companies.
REQUIRED
Advise the controller on the possible transfer pricing methodologies that could be applied to the above transactions under section 247. Indicate why discarded methodologies would not be appropriate. Describe how you would apply these methodologies and indicate what additional information you will need from the client to help you determine the appropriate methodology.