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Business Adviser

Is your business model ready for the 21^st century global trade?

By Dennis Fortnum
Canadian Managing Partner,
KPMG Enterprise

Despite market turns, the playing field is wide open for Canadian businesses of any size to be successful growing their business on the world stage. And many business leaders of Canadian private companies are doing exactly that. Over the past three years as we talked with business owners regarding their strategies to expand or enter new markets – almost all of the companies we surveyed reported that they transact business beyond our borders and more than half of the business owners interviewed said doing business abroad was important to their company’s overall growth strategy.

We are often asked, “At what stage of development should a private company consider expanding globally?” We suggest owners and entrepreneurs think of it from the very start – it’s a mistake to think about it after the fact. Building a business strategically is a long term venture. Success in other markets requires homework and a sound business plan but importantly it requires relationships both here and abroad.
Some misperceptions exist about doing business globally:

• Foreign markets are too risky
• The company does not have the skills or resources to succeed in the United States – or abroad in high growth markets like China, India and Russia
• The products or services aren’t considered ‘exportable’
• The business is better off remaining domestic and ‘manageable’

These are worthy concerns, however the potential risks while sometimes daunting are worth the reward. The case for continued globalization remains strong. Canadian private companies should lead the way; we have the talent, innovation and intangible quality of being Canadian, which we can leverage to seize market opportunities.

Canadian companies should not overlook the significant potential gains of going global. Regardless of size, any business can be successful in foreign markets. Despite financial crisis scenarios of countries like the US and Greece, now is not the time to be complacent or withdraw from the market. Canadian business owners need to be on the world stage sharing our products, services, ingenuity, great ideas and good business sense.

As a leader of a private business, it is important to choose an expansion strategy that is in sync with your business goals and objectives. This edition of Business Adviser covers a snapshot of subjects related to building business opportunities in markets outside of our country. Watch for the release of the next edition of Taking on the World scheduled for early 2012. This research report looks at how Canadian companies have fared building their business beyond our borders and will include a special feature regarding financing to support global expansion strategies.

If you’re doing business abroad or thinking about expanding your business internationally, KPMG Enterprise gives you ready access to all KPMG’s resources across Canada and the power of KPMG member firms around the world. We can provide you with information on local business practices, regulatory issues and specific tax considerations for any country you might be expanding to or considering doing business in. Visit kpmg.ca/goglobal for recent articles and reports that might help you enter new markets.

My market is different

By Niraj Dawar
Professor of Marketing at the Ivey Business School

International markets offer alluring opportunities for Canadian private businesses. But there is a catch. The catch is you will feel pulled to localize when your entire reasoning for going there was to benefit from scale – to standardize.

Speak to enough local managers of international companies in countries around the world and you’ll soon come to expect the all too common refrain: “...but my market is different.”

Ask them to elaborate, and you’ll get the low down on how consumer habits in their market are different, their consumers' purchase behavior is different, preferences and tastes are different, how the media and the retail trade are different, and how their consumers and customers require unique, tailored, and delicate handling.

And while you're wondering "different from what?", the manager is on to her next refrain: “why do the folks at HQ just not get it?” “How can they not see, or choose not to see the differences?”; “why do they prefer a standardized, cookie-cutter approach, when a tailored approach would put us miles ahead of our competitors....”

In the eyes of the HQ, these protestations are either irrelevant, or they are merely ways for local managers to justify (magnify?) their crucial role as interpreters of the global strategy for the local market.

Fact is, it’s a bit of both – local differences exist, and local managers love to dwell on them.

We can all agree that there are some differences you have to adapt to: Even companies that strive for and rely on global standardization for efficiency and economy must concede some local differences. McDonald’s must advertise in French in Quebec, and will not serve beef patties in India. And measurements are metric everywhere, but not in the United States and Myanmar. So these aspects require localization or you can’t play in the local market. Smaller companies must be even more careful – their costs of localization can quickly add up and eat into the bottom line.

But the friction when going international tends to be about the more subtle differences: the Kellogg’s manager who says Raisin Bran® is too bland a breakfast choice in Korea; or the chocolate company brand manager who says that black is not the right packaging color choice in China. Should you listen to the local manager, or stay the course?

Of course, both HQ and the local managers are really trying to assess:

• How large are these local differences, and do they “matter”?
• In other words, should they affect how the brand is positioned and presented, whether the strategy is adapted or not?
• Are the differences sufficiently important to undermine the central premise of the brand and strategy?

The tricky part is that the answers to the questions are subjective. Local managers see these differences up close, so they seem big; global managers see plenty of such differences in local markets, so they seem trivial.

How the company responds to them depends on the culture of the company and the extent to which local managers have a say. And of course, on the size of the market opportunity – does it justify localization.

Over the next couple of decades any business operating internationally expects a good chunk of its growth to come from China, India, and other emerging economies. And even companies that have so far resisted localizing are now re-examining their strategies.

As these markets grow in size and importance, so will the influence that local managers in those markets have on the direction of the global brand, product portfolio, and company strategy.

Savvy companies may even take new product ideas and even brand propositions from China and India, and bring them to the rest of the world. In an ideal scenario, the flow of products and ideas becomes a two-way street. The business opportunity here is to spot the potential of local ideas, and bring them back home or apply them to other markets in which you operate.

Take a Canadian multinational that began as an entrepreneurial venture in New Brunswick a few decades ago, and is well known for its deep roots in many local markets around the world: McCain Foods. The company is the world's largest frozen French fry maker – nobody knows potatoes better than McCain. On entering the Indian market, managers find that there’s a large market for aloo tikki (Indian potato patties), a product that the company has never made or sold before. But since no one in India sells them frozen, McCain seizes the opportunity. The company develops and launches the popular snack in India. It’s a success, and it even wins the SIAL d'OR (at one of the world's largest food trade shows, the Salon international de L'alimentation) prize in Paris. 

And eventually, the company may even find that there is a global market for a well-positioned aloo tikki. 

In that not too distant scenario, the local manager in India may be placed in the unfamiliar position of arguing that consumer preferences worldwide are in fact similar: "everyone'll love an aloo tikki!".

The lesson for Canadian private businesses is that operating in international markets is not just a cost, it is an opportunity. You’re not just bringing a bit of Canada to those countries, you’ve also got the opportunity to learn from those markets – about new products, new processes, new competitors, and new ways of competing. International expansion is not just about making more money elsewhere – the real value is that it will change your company for the better.

An earlier version of this article appeared on Just Marketing (www.nothingbutmarketing.blogspot.com) under the title “No, Really, My Market is Different.”

Setting up operations abroad?
Welcome to the wonderful world of transfer pricing

By Joe Devitt
Partner, KPMG Enterprise/Waterloo

Finally - your hard work has paid off. You’ve spent several years establishing your brand in the Canadian market and enjoy a healthy market share. And now all of your research indicates there will be significant demand for your product in the US. After careful consideration, you have set up a US subsidiary to sell your product in the US, and you are ready to send your first shipment. The only thing left is to determine the price at which you will transfer the product to the US related party. As the business owner contemplating this, several questions enter your mind…

“Everything is eliminated on consolidation – does it really matter what price I use?”

“This is my company – surely I can establish pricing as I see fit?”

“Can’t I price my product to take advantage of the tax rate differential between Canada and the US?”

Welcome to the wonderful world of transfer pricing.

If there is any cross-border tax issue that has the potential to cause significant financial uncertainty within a company, it’s transfer pricing. Transfer pricing is simply the price charged for transactions between related parties. Pricing between related parties has historically been a contentious issue with tax authorities around the world, but there has never been as much mainstream focus on the issue as there is today as those tax authorities attempt to rein in badly-needed tax dollars to deal with budget shortfalls. The US government in particular has placed a bull’s-eye squarely on the topic of transfer pricing, as demonstrated by hearings held by the House Ways and Means Committee to address concerns that US taxpayers may be inappropriately shifting income outside of the US through the manipulation of transfer pricing.

Similar to other OECD-member countries, Canada has a specific section of its tax law addressing transfer pricing. These laws also contain potentially significant penalties for non-compliance. In a nutshell, pricing between related parties who are resident in different countries is required to reflect “the arm’s length principle”, which refers to the price at which two arm’s length parties would have transacted under similar circumstances. While this definition appears straightforward, the decisions from various tax courts worldwide, and the statistics published by the Canada Revenue Agency (CRA), tell a much different story. Transfer pricing is a very complex area, and requires a combination of tax law, economics, accounting, and as one judge put it in a recent ruling, “a good dose of common sense”¹.

Thankfully, even with all of this scrutiny by the tax authorities, a taxpayer can at least protect itself from transfer pricing penalties simply by having the required transfer pricing documentation in place. In this regard, the CRA has published guidelines to assist taxpayers in understanding what specific documentation must be prepared. Although the requirements may appear onerous, the up-front work required is certainly worth the effort. In addition to serving as penalty protection, having the appropriate transfer pricing documentation in place is the first step in preparing a line of defense for when (not if) the CRA comes calling in the course of a transfer pricing audit. When you consider the number of taxation years available for CRA to review, the old adage “an ounce of prevention is worth a pound of cure” is well-illustrated. For example, if the CRA were to begin an audit of a taxpayer today, it could examine transfer pricing as far back as 2003. Given the additional tax, interest and penalties that can accrue, taxpayers should not underestimate the financial consequences of having insufficient support for their transfer pricing.

So, as you prepare that first intercompany pricing invoice, ask yourself whether you are prepared to defend your transfer pricing, both in Canada and abroad, and whether you have the transfer pricing documentation in place to give you the comfort you need so you can focus on what really matters – growing your business.

¹See General Electric Capital Canada Inc. v. The Queen, Can. Tax Ct., 2006-1385(IT)G, 12/4/09

Importing and Exporting? – Top ten things your business should know

By John Pajek
Senior Manager, KPMG Enterprise/Toronto

As your business grows, you might start importing or exporting goods. When you do, you’ll have to deal with complex customs rules but if you prepare correctly, you may be able to reduce your costs and paperwork and create a streamlined international trade process for your business. On the other hand, incorrect declarations can result in costly penalties, increased scrutiny by the customs authorities or even suspension of importer/exporter privileges.

For example, I know a company that imports goods with a very specific end-use for their industrial equipment product. Based on our review, we discovered this importer’s goods qualified for an end-use tariff code that would exempt them from duty. By applying the end-use tariff code, this importer got a refund of more than CAD$1 million for four years’ worth of overpaid duty.

To help your company develop an efficient process for its importing and customs compliance to improve your cash flow, the top ten things you need to do are:

Open an import/export account with the Canada Revenue Agency (CRA) — If you already have a business number with the CRA, you’ll need to activate an import/export account against that number.

Know your imported goods and their end-use — Imported goods are subject to different duty rates depending on what they are and sometimes on how they’re ultimately used. Some products can be imported at a reduced customs duty rate or duty-free if they meet the requirements of “end-use” tariff codes or qualify for other Canada Border Services Agency’s (CBSA) duty relief incentives.

Identify the country of origin, manufacture and export of your imported goods — Canada has trade agreements with several countries that usually allow goods imported directly from these countries to enter duty-free or at a reduced duty rate with a valid certificate of origin. Most trade agreements require the goods be shipped directly from the beneficiary country to Canada on a through-bill of lading. Identifying where the goods will be shipped from is essential before importing.

Declare the correct value of imported goods — Canada has several methods to determine imported goods’ correct value for customs. The selling price, possibly with adjustments, is the most common value declared on import. Vendor invoices should provide a complete and accurate description of the goods, the selling price and conditions and terms of sale.

See whether you can save GST — GST is payable on most imported goods but several categories of goods are zero-rated or GST-exempt — it’s worth checking on the GST status of your imported goods.

Ensure you can legally import or export your goods — Some goods are controlled, regulated or prohibited by the CBSA or other government departments. It’s important to determine in advance whether your goods fall into any of these categories.

Meet your marking and labeling requirements — Imported goods are subject to strict marking and labeling requirements, for example, for the country of origin. It’s important to ensure your imported goods meet their labeling requirements so you can sell them in Canada. It’s best to address these issues before the goods leave the exporting country.

Get written agreements with service providers — If you hire a customs broker, transport company or other service provider, you are still responsible as the importer/exporter of your goods. It’s a good idea to write instructions outlining each party’s responsibilities to ensure you comply with all the customs rules.

Document your procedures — As an importer or exporter, you must ensure the information declared to the CBSA on your behalf is accurate. Penalties for non-compliance will be issued to you, not your service provider. Your documented procedures should include a post-entry review to identify errors in value, tariff classification or origin and submit corrections to the CBSA on time.

Follow the rules to avoid penalties — If your company doesn’t comply with customs laws, you could end up paying penalties ranging from $100 to $25,000 per infraction under the Administrative Monetary Penalty System (AMPS).

Customs rules don’t have to get in your way. As long as you take care to meet your customs obligations, moving goods across borders can go smoothly and your business can continue to grow.

Business Adviser

Trade with the United States can be taxing

By Larry Evans
Partner, KPMG Enterprise/North York

Canadian private companies doing business in the U.S. need to be wary of the inevitable federal and state tax consequences. Understanding federal and state tax compliance before entering the U.S market can mitigate exposure to unforeseen tax traps and contribute to profitability.

Even if private companies don't have physical facilities in the U.S., they can be subject to one or more federal, state or local taxing regimes. Penalties for non-compliance often exceed 50 percent of the tax due. Even worse, some federal tax penalties for failing to file information returns are $10,000 per occurrence so it is crucial for private companies to ensure they are fully compliant with U.S. tax requirements.

Thanks to the U.S./Canada tax treaty, a company outside the U.S. generally has to have a "permanent establishment" in the country to be subject to U.S. federal income tax. Although this includes bricks-and-mortar places of business such as offices and factories, a sales representative or agent can create a permanent establishment if he or she can conclude contracts in the U.S. Recent changes to the U.S.-Canada tax treaty lower the threshold for projects in the U.S. to create a permanent establishment.

However, just because a company lacks a permanent establishment doesn’t mean there are no U.S. or state filing responsibilities. Activities in the U.S. that do not create a permanent establishment may still obligate a company to file a U.S. federal income tax return. In addition, since not all states follow the treaty, some states may subject a company to state income tax even if it doesn’t have a permanent establishment. Plus, treaty protection does not extend to non-income taxes, such as sales taxes.

States use a concept called "nexus" to determine the minimum contact necessary for the state to impose its various taxes on an out-of-state company. Different state taxes can have differing nexus standards. Recently, many states have followed a trend to lower the nexus bar.

An actual in-state physical presence created with inventory or other property as well as by employees, independent agents, representatives or contractors, has been traditionally required for state sales tax nexus. Today, some states, such as New York, assert that some types of virtual presence through the Internet can be enough to create nexus. Also, many states assert that the presence of intellectual property such as a trademark creates nexus for income tax. Some of the newer state tax regimes, such as those in Ohio and Michigan, even disregard any requirement for in-state presence but instead focus on activities targeted at customers in the state.

State sales-and-use tax compliance can be more difficult and expensive than income taxes given that there are over 8,000 taxing jurisdictions involved. Once an out-of-state company satisfies the nexus standard for sales and use tax, the burden of collecting taxes on purchasers of taxable goods and services begins. If a company fails to collect from its customers, it effectively converts a customer's tax into its own liability. Although Canadian private businesses can generally credit U.S. federal and state income taxes paid against their Canadian corporate income taxes, the same cannot be said for sales, use and other taxes that are not based on income.

Whether Canadian private companies are expanding in the United States with their own business or buying other companies, they should definitely consider U.S. federal and state taxes before proceeding.

The global imperative and risks

By Bruce Willis
Partner, KPMG Enterprise/Regina

By Angela Mitchell
Partner, KPMG Enterprise/Toronto

By Lloyd Mills
Senior Manager, KPMG Enterprise/Toronto

Private companies across the globe increasingly regard global expansion as core business strategy. Such expansion may be driven by opportunities to take advantage of growth in emerging markets, to expand business opportunities in developed markets and/or the need to establish international locations to meet customer demands and expectations.

In the Canadian context, such expansion will most often mean doing or expanding business in the United States. However, increasingly, Canadian private companies are looking further abroad for opportunities, whether in the developed markets of Europe and Australia or in key emerging markets in Asia and South America.

To understand better this growing trend toward global expansion by Canadian private companies, KPMG Enterprise conducts annual surveys of the global activities of a wide-ranging group of Canadian private companies. Our research has provided a number of interesting findings:

• Global expansion remains an area of significant focus amongst private company leadership teams who see foreign operations as key to their company’s overall growth plans and forecast continued global expansion over the next several years.
• Canadian private companies are “going global” in a variety of ways. In the vast majority of cases going global involves either the exporting or importing of goods and services or non-Canadian distribution. However, an increasing number of companies are going global in more comprehensive and complex ways, for example: through partnerships, alliances and joint ventures, through investment in offices, stores and production facilities off-shore and/or through completing formal off-shore acquisitions.
• The drivers for global expansion by Canadian private companies are also varied but tend to relate generally to opportunities to grow their business through exploiting untapped market opportunities or capitalizing on larger markets outside of Canada.

Global expansion provides opportunities & entails risks

There is much to be gained through global expansion. However, it is important for private company executives to recognize and remember that there are a variety of risks that are the natural by-product of global expansion.

As reflected in the KPMG Enterprise survey results noted above, global expansion can take a variety of forms. The opportunities associated with each approach to global expansion will differ and so will the associated challenges and risks. However, there are a number of risks that private company executives should always consider when assessing any potential global expansion plan:

• Strategic Risks related to the economic climate of the target country or countries, in particular economic growth prospects, industry structure, competitiveness and the geopolitical risk associated with the target country or countries
• Legal & Regulatory Risks related to the maturity of the target country’s legal system and compliance with both target country laws and regulations and business conduct laws and regulation with extra-territorial application [e.g., Foreign Corrupt Practices Act (US)]
• Operational Risks related to transportation and distribution logistics, supply chain management, information technology and human resource
• Financial Risks related to target country taxation, transfer pricing, foreign exchange and credit and capital availability
• Cultural Risks related to ensuring that your business tactics, management practices and products and services are consistent with local cultural norms
• Due Diligence Risks related to ensuring the quality and trustworthiness of any local partners or related to the assessment of any potential acquisitions in the target country

The potential complexity of the risks associated with any global expansion can be highlighted with a “simple” example. Company A has chosen to enter into a partnership with a distribution firm based in Mexico to distribute its products across the countries of Central America. The list of potential risks that Company A should consider when assessing and planning this initiative could include:

• Economic – how large is the Central American market for their goods? How competitive is that market?
• Geopolitical – how stable are the governments of Central America? Are there any specific socio-political risks associated with distributing goods in these countries – e.g., risks associated with the security of goods? Are there potential human rights or environmental issues in the target countries that could result in reputation risk to Company A?
• Legal – how can Company A monitor the activities of its partner to ensure that its activities are consistent with both the business conduct legislation and regulations in the various target countries and more broadly applicable business conduct legislation? Are there any concerns with the enforcement of contracts either in Mexico or the various Central American countries should contractual issues arise?
• Operational – is the local infrastructure sufficient to support the efficient and effective distribution of the product? Are there issues related with the supply chain – i.e., can Company A assure that it can provide its product to its partner on-time and in the necessary quantities?
• Financial – can Company A ensure that it monitors and complies with relevant tax rules in both the various external locations (Mexico, Central American countries) and domestically? Are there issues related to the availability of credit arrangements in the target countries? What is the potential foreign exchange risk associated with distribution in the various countries?
• Due Diligence – how can Company A ensure that the proposed Mexican partner is appropriate? How can Company A ensure that any parties with which the Mexican partner transacts in the various Central American countries are appropriate?

These and likely a host of other risks would need to be considered by Company A executives before proceeding with their proposed initiative and must be managed as the initiative is rolled out. Our “simple” example, therefore, highlights the variety of risks that must be identified, assessed and managed to ensure the success of any global expansion.

A key mechanism for ensuring that the risks associated with any global expansion plans are assessed and managed and monitored on an ongoing basis is through the use of an enterprise risk management (ERM) program. While a robust ERM Program, such as those employed at larger companies in Canada and across the globe, may not be appropriate for smaller, middle market or private companies, they can usefully adopt ERM practices to help identify, assess, manage, monitor and report on the risks associated with their global expansion.

The evolution of ERM to private companies

Increased global risks combined with rapidly evolving business conditions are prompting more private companies to turn to ERM. While private companies’ needs differ from those of large corporations, these companies can still realize significant benefits, especially since ERM practices have also been evolving to become much more flexible and scalable to all types of businesses.

Some private companies may not be at the point where their size, operations, structural complexity, or stakeholder expectations dictate the need to employ all aspects of a robust ERM process. However, many private companies are facing increased complexity in their business operations and have successfully applied ERM practices to manage this complexity including key globalization risks.

Too often, organizations move forward on initiatives with a focus only on the upside, or because they feel they have no alternative if they want to keep up with competitors. An ERM program can prompt private companies to pause and consider what may go wrong and prevent them from meeting the objectives of their initiatives.

Scaling ERM

In addition to helping to drive ownership of risk, ERM can help bring risk awareness, consensus on priorities, and collaboration on addressing issues. A vehicle increasingly used by larger organizations to create this environment is a risk committee or risk council. Private companies could use a similar approach to create a risk-aware, collaborative management team that has consensus on priorities without formally establishing a risk committee. For instance, by simply including a standing agenda item at monthly or quarterly meetings of the direct reports to the CEO, a company could discuss the top 10 to 15 risks and challenges it faces as it develops its globalization strategy. Topics could include the following:

• Have any of our risks increased beyond an acceptable level since we last met? If so, what is causing the increase? What do we need to do in order to respond to or mange the consequence of the increase? Is there anything we can do to prevent this from happening again?
• Are the actions we agreed to take to lower the risk on track? If not, do we need to allocate more resources or try an alternative approach?
• Are there any emerging issues or risks that we should add to our top risk list? If so, what do we need to do to either prevent the risk from occurring or respond to and/or mange the consequences if the risk is beyond our control?

By focusing on the top 10 to 15 risks, management can create an ongoing risk assessment and management process that is not an administrative burden to maintain and still realize significant benefits.

Going forward

Private companies are expected to continue moving forward with globalization, but recent market conditions coupled with the business’ previous performance in achieving its global expansion goals will likely be mixed expectations. However, private companies that leverage ERM techniques to identify key risk and issues to create a risk-aware culture will be in a better position to succeed. Regardless of size and ownership structure, companies that take a proactive, strategic approach to risks can potentially stay a step ahead of their competitors.

Business Adviser is published by KPMG Enterprise™ specifically for owners and executives of private companies. KPMG Enterprise is devoted exclusively to helping business owners and entrepreneurs build thriving enterprises. For further information about how KPMG Enterprise can help private companies, visit www.kpmg.ca/enterprise.