Canada Transfer Pricing Reforms Would Make Compliance Pricier

Canada’s proposed transfer pricing reforms aim to bring the country’s tax laws more in line with international guidelines by tightening how corporations justify pricing within their own global operations.

If enacted, the reforms are likely to add complexity, uncertainty, and compliance costs. Multinationals should watch closely to gauge how the new rules might affect investment and Canada’s broader business climate.

Proposed Revisions

A key feature of the new legislation is a more explicit focus on the parties’ “actual conduct.” Going forward, transactions will have to be analyzed accordingly by reference to a non-exhaustive list of “economically relevant characteristics” that aren’t limited to contractual terms. This change is likely to create even more expansive audits for multinationals operating in Canada.

The proposed legislation expressly incorporates the OECD guidelines by reference, stating that arm’s length conditions are to be determined “so as to best achieve consistency” with the guidelines. The guidelines are drafted as nonbinding standards and continually evolve in response to international developments. Their incorporation into domestic legislation invites further uncertainty.

The proposals also tighten compliance rules. Companies would have only 30 days—down from 90—to provide transfer pricing documentation at the tax authority’s request. There would be a simplified documentation option, and the threshold for penalties would double from $5 million to $10 million. This should provide some relief in cases involving less significant adjustments.

Impetus for Change

The Department of Finance began reviewing existing transfer pricing legislation four years ago. The reform initiative was spurred by the Supreme Court of Canada’s refusal to weigh in on the Federal Court of Appeal’s decision in Canada v Cameco Corp.

In a 2023 Consultation Paper targeting Canadian transfer pricing reform, the Department of Finance stated that this decision highlighted a “lack of detail” in the Canadian legislation and an “overemphasis on intra-group contracts, rather than on the factual substance of transactions.”

Respect for legal form is otherwise entrenched in Canadian tax law. Although it’s uncommon to see explicit legislative direction emphasizing “factual substance” over contractual arrangements, as a practical matter, courts don’t analyze or apply the law in a factual vacuum.

Business Implications

It’s unclear how the new concepts will be interpreted or applied in practice; the impact of these changes will become more evident only when cases start making their way through the court system. That said, the shorter turnaround time for responding to requests from the tax authority for documentation likely will increase compliance pressure in the immediate term.

To date, Canadian courts have confirmed that—even under the existing legislation—transactions should be priced having regard to economically relevant characteristics such as functions performed by the parties, the assets employed, the risks assumed, market conditions, and the like.

Transfer pricing audits have long focused on these types of factors, even though the legislation didn’t explicitly require it. To this extent, the “actual conduct” of the parties has always informed the administration of Canadian transfer pricing law.

The new “consistency” rule is problematic, because the Organization for Economic Cooperation and Development’s guidelines contain principles-based language that itself is open to considerable interpretation. In prior cases, Canadian courts have considered the guidelines when interpreting existing legislation, even while cautioning that they “are not controlling as if they were a Canadian statute.”

As the guidelines may not always align with Canadian statutory provisions or case law, a better approach would have been to continue using the guidelines as persuasive interpretive aids rather than giving them the force of law.

Key Takeaways

Transfer pricing isn’t an exact science. In any given case, there’s a range of potentially “correct” outcomes.

While the explicit emphasis on actual conduct and economically relevant characteristics may may seem novel at first blush, well-advised businesses should be striving for intercorporate documentation that reflect their actual dealings.

Canada says these changes are necessary to strike a balance between fairness for taxpayers and protection of the tax base. But the courts ultimately will decide how much the changes will impact the status quo.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Pooja Mihailovich is a partner at Blakes and co-leads the tax controversy and litigation group.

Erich Schultze is an associate at Blakes and specializes in resolving tax disputes.

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