Canada’s Transfer Pricing Overhaul Demands Proactive Preparation

Canada enacted significant changes to its transfer pricing rules last month, a comprehensive overhaul that shifts from a form-over-substance approach to one more closely with OECD standards.

Multinational enterprises doing business in Canada and their advisers will need to navigate this new environment with care.

These major transfer pricing updates are expected to affect not only multinational enterprises doing business, but also the overall volume and intensity of transfer pricing audits in Canada. In the related budget documents, the government indicated that it anticipates an increase of approximately CA$500 million ($363 million) in federal revenue over the next five years as a result of the changes.

Key Considerations

The new transfer pricing rules reflect Canada’s dissatisfaction with how the courts analyzed cross-border intercompany transactions. The government considered the existing rules overly focused on legal form and argued that this approach often led to profit allocations that didn’t accurately reflect the parties’ actual economic contributions.

Substance over form. The new rules now focus on “substance over form.” Under the new transfer pricing framework, multinational enterprises must analyze cross-border intercompany transactions by examining their contractual terms and a set of legislated comparability factors referred to as “economically relevant characteristics.” These include:

• Contractual terms
• Functions performed
• Assets used and risks assumed
• Industry practices
• Characteristics of the property or services
• Economic and market circumstances
• Business strategies

This list is intended to be non-exhaustive. The change in the new transfer pricing rules places greater weight on the parties’ actual conduct and the economic reality of the transaction, rather than relying solely on intercompany legal agreements.

Transfer pricing audits are expected to become broader and more fact-intensive as a result. In response, multinationals should reconsider their transfer pricing policies—and the documentation prepared to support them—to ensure they meet the new legislative requirements.

New transfer pricing adjustment rules. The new rules give the Canada Revenue Agency a powerful tool to adjust transfer prices and intercompany transactions it considers inconsistent with the arm’s-length principle. Canada’s pricing adjustment rule (subparagraphs 247(2)(a) and (c)) and recharacterization rule (subparagraphs 247(2)(b) and (d)) have been replaced with an all-encompassing adjustment rule that permits the revenue agency to adjust transfer prices or intercompany transactions that differ from those that would have been agreed to by arm’s-length parties.

This new adjustment rule is broad and will take years to interpret in the courts. In the meantime, the revenue agency is expected to explore the effectiveness of the new adjustment rule to recharacterize and replace intercompany transactions that it considers to be inconsistent with the arm’s-length principle. Such transactions include outbound transfers of intellectual property, outbound financing structures, and transactions involving foreign affiliates with little or no substance.

Increased penalty thresholds, expanded documentation requirements, and reduced time to submit documentation. The new rules increase the threshold for levying a transfer pricing penalty. Multinational enterprises are now subject to a transfer pricing penalty if they are reassessed with a transfer pricing adjustment more than $CA10 million (up from $CA5 million) or 10% of gross revenue.

Taxpayers can still protect themselves from a potential transfer pricing penalty by preparing contemporaneous documentation. Canada’s new rules expand the documentation requirements to satisfy the penalty protection rule, as they now include an examination of the economically relevant characteristics.

The update also significantly reduces the timeframe for submitting transfer pricing documentation to the revenue agency during an audit, from three months to 30 days. Taxpayers still must prepare and maintain contemporaneous documentation by their filing due date to meet the penalty protection rule. But for multinational enterprises that have chosen not to seek penalty protection because the increase in the threshold has reduced their penalty risk, the shortened response period will intensify pressure on audit readiness.

In practice, many taxpayers may face challenges in meeting this new deadline, particularly those with complex cross-border structures or those that have simply procrastinated and haven’t previously prepared any documentation.

Call to Action

Although the new rules may increase uncertainty and add complexity to audits and disputes, taxpayers can take proactive steps to mitigate potential transfer pricing adjustments:

Reevaluate existing structures and assess commercial rationality. Taxpayers should undertake a comprehensive reevaluation of existing transaction structures to confirm the actual conditions align with arm’s-length conditions that independent parties would have agreed to.

This reevaluation should include assessing the commercial rationale for each transaction and ensuring that it is supported by valid business purposes and an appropriate transfer pricing analysis. A reevaluation also should reexamine transfer pricing policies based on administrative convenience.

Align contractual arrangements with actual conduct. Taxpayers should review their intercompany agreements and verify that the contractual obligations set out in governing agreements accurately reflect the parties’ behavior and activities. Any misalignment between contracts and conduct may increase audit risk under the new rules.

Update documentation and prepare for increased audit scrutiny. A gap analysis may be an appropriate starting point to identify whether additional information—such as policies, procedures, and governance documentation—is required. Taxpayers should update transfer pricing documentation to reflect the new statutory concepts, including the economically relevant characteristics.

Special attention should be paid to the absence of legacy provisions. Transactions implemented before Nov. 4, 2025, but with continuing effects in subsequent taxation years, may be analyzed differently under the new regime. Accordingly, taxpayers may need to prepare additional documentation to ensure compliance.

Given the new 30-day response deadline, taxpayers should proactively strengthen their documentation and ensure it is complete, accurate, and readily accessible before any revenue agency audit is initiated.

Outlook

Proactive preparation is essential in an environment increasingly driven by economic substance. As Canada enters a new era in transfer pricing, businesses engaged in cross-border intercompany transactions should act now to align their structures, documentation, and governance with the evolving rules.

This new landscape will bring significant changes, but businesses can nevertheless position themselves to make the most of them.

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

Author Information

Sonia Gobeil is a senior manager at KPMG Canada’s National Tax Centre in Montreal.

Brad Rolph is partner and national growth and development leader of transfer pricing at KPMG Canada.

Demet Tepe is partner and national leader of the transfer pricing services team at KPMG Canada.

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