Canada’s New Transfer Pricing Proposal Likely to Face Criticism

The Department of Finance Canada is proposing amendments to the country’s transfer pricing rules. The changes—heavily influenced by the OECD’s base erosion and profit shifting project—mark a departure from the language in the existing transfer pricing rules in Section 247 and elsewhere in Canada’s Income Tax Act.

The government says it wants to align Canada’s transfer pricing rules with the 2022 version of the Organization for Economic Co-operation and Development’stransfer pricing guidelines, which includes the BEPS revisions, and to address the belief that “the current transfer pricing rules permit the shifting of excessive amounts of income out of Canada.” Stakeholders are invited to provide comments on the proposed changes by July 28.

Canada announced its intention to review the country’s transfer pricing rules in 2021, after the Supreme Court of Canada rejected the Canada’s Review Agency’s bid to overturn the Federal Court of Appeal’s decision in Canada v. Cameco Corp. The appeals court had rejected the Canada Revenue Agency’s challenge to Cameco’s decision to set up a Swiss subsidiary to acquire uranium from Cameco and third parties, and then sell the uranium indirectly to customers around the world. The panel upheld the Tax Court of Canada’s finding that Cameco’s sale of uranium to its subsidiary was done on arm’s length terms and conditions.

The government’s interpretation of Cameco, contained in a recent consultation paper and draft legislative amendments, as well as the strength of its articulated need for the proposed new rules, warrant close scrutiny and are likely to face criticism in the consultation process.

Tracing the Steps

The arm’s length principle requires transactions between non-arm’s length parties to be priced as though the parties were dealing at arm’s length. The consultation paper outlines two steps in the comparability analysis at the heart of the arm’s length principle, reflecting the guidance set out in the OECD transfer pricing guidelines.

Step one involves identifying the conditions and economically relevant characteristics of the tested transaction, while step two compares these conditions to comparable transactions between independent enterprises.

Under step one, which establishes the starting point for the comparability analysis, the first proposed amendment is to determine and analyze what is referred to as the delineated transaction or series based on its economically relevant characteristics.

The second proposed amendment under step one is to define these characteristics to include:

• Contractual terms of the tested transaction or series—notably, only to the extent these are consistent with the participants’ actual conduct.
• Actual conduct of the participants in the transaction or series, including functions performed, taking into account certain factors.
• Characteristics of property transferred or services provided.
• Economic circumstances of the participants and the market in which they operate.
• Business strategies pursued by the participants.

Under step two, the consultation paper proposes a rule calling for a comparison of the conditions—to be construed broadly based on an interpretive rule to include all relevant information to determine the tax results of a transaction—of the delineated transaction or series to the conditions that would have been included in comparable circumstances had the parties been dealing at arm’s length.

A transaction or series is, in turn, deemed to fail the comparison if a condition doesn’t exist but would have existed had the parties been dealing at arm’s length in comparable circumstances.

The proposals also would replace the recharacterization rule in paragraphs 247(2)(b) and (d) with a rule that would disregard and replace a delineated transaction or series as structured by the parties with an alternative transaction or series.

The non-recognition and replacement rule would apply if the delineated transaction or series differed from one that would have been entered into by arm’s length participants dealing in a commercially rational manner in comparable circumstances, and it prevents the determination of an arm’s length transfer price.

It would substitute a transaction or series that “comports as closely as possible with the facts of the delineated transaction or series while achieving an expected result” that would have been “commercially rational.” Unlike the existing recharacterization rule, the proposed replacement rule would apply regardless of whether the participants sought or expected a tax benefit to result from the transactions as structured.

Lastly, the draft amendments include a proposed consistency rule requiring Section 247 to be applied consistently (unless the context otherwise requires) with the OECD transfer pricing guidelines. This is defined to be a reference to the 2022 guidelines or to any future versions—or indeed, any other unspecified text—later prescribed by regulation.

Lack of Clarity

The draft amendments don’t specify a coming-into-force date for the proposals. However, the consultation paper suggests that they are expected to apply prospectively. Our experience has been that the Canada Revenue Agency increasingly relies on the application of BEPS concepts in audits of taxation years that pre-date BEPS revisions.

This raises the question of whether the government will treat these proposals as a substantive change to the existing transfer pricing legislation, or instead attempt to position the draft rewrite as a mere clarification or refinement of the arm’s length principle in Section 247. The answer to this question will have significant implications for businesses and taxpayers with ongoing transfer pricing disputes.

Moreover, the potential impact of the proposals is difficult to determine with certainty. While the consultation paper includes numerous references to Cameco, suggesting that the government believes the proposed amendments would lead to different results, the practical implications of the proposals remain to be seen.

Canadian courts, including those that decided Cameco in the taxpayer’s favor, have referred to prior versions of the OECD’s transfer pricing guidelines and have already expressly considered “economically relevant characteristics” in deciding transfer pricing cases under the existing legislative framework.

It is unclear whether the proposals’ explicit incorporation of these, or their reference to actual conduct—an undefined and arguably redundant term—marks the sea change that the government seems to think is warranted.

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

Peter Macdonald is a partner with the tax group at Osler, Hoskin & Harcourt, with a particular focus on transfer pricing and international tax matters. He served as counsel to the taxpayer in Cameco.

Amanda Heale is also a partner with the tax group at Osler, Hoskin & Harcourt. Her tax advisory practice focuses on tax controversy and litigation, international tax and transfer pricing.

Kaitlin Gray is an associate with the tax group at Osler, Hoskin & Harcourt. Her practice focuses on tax controversy and litigation and international tax.

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