Transfer Pricing 2023

Last Updated April 13, 2023

Canada

Law and Practice

Authors



Miller Thomson LLP is a national business law firm with approximately 525 lawyers across five provinces in Canada. The firm offers a full range of services in litigation and disputes, and provides business law expertise in mergers and acquisitions, corporate finance and securities, financial services, tax, restructuring and insolvency, trade, real estate, labour and employment, as well as a host of other specialist areas. Clients rely on Miller Thomson lawyers to provide practical advice and good value. The firm has close to 60 tax practitioners, with its transfer pricing lawyers primarily located in its Vancouver, Calgary, Toronto and Montreal offices. From planning to controversy, the firm’s transfer pricing lawyers have advised multinational companies in numerous sectors, including but not limited to, automotive, forestry, telecommunications, pharmaceuticals, software, business management, fashion, and banking and finance.

The rules governing transfer pricing in Canada are primarily contained in Section 247 of the Income Tax Act (Canada) (ITA). Subsection 247(2) of the ITA provides that when a Canadian taxpayer and a non-resident person do not deal at arm’s length, the Canada Revenue Agency (CRA) may make any adjustments to the transfer prices necessary to reflect the quanta or nature of the amounts which would otherwise have been consistent with the terms of an arm’s length transaction (the “Primary Transfer Pricing Adjustment”).

Some provincial and territorial corporate income tax legislation include transfer pricing rules, which are aimed at harmonising the federal transfer pricing rules set forth in the ITA.

Further, the CRA issues transfer pricing memoranda (TPM) intended to supplement and provide additional clarity and guidance in respect of Canada’s transfer pricing legislation. Prior to 30 December 2019, the CRA published its administrative guidance in respect of transfer pricing in its longstanding Information Circular 87-2R (“IC 87-2R”). IC 87-2R was then cancelled to ensure that the CRA’s guidance would be aligned with changes in the OECD’s Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrators (the “OECD Guidelines”). Although not a part of Canadian law, the CRA has consistently endorsed the OECD Guidelines and has generally aligned its assessing policy with them.

Canada’s transfer pricing legislation had previously been contained in Prior Section 69 of the ITA before 1997. Following the introduction of the OECD Guidelines in 1995, which affirmed the significance of the arm’s length principle, Canada revised its international transfer pricing provisions to include new Section 247 and new Part XVI.I of the ITA. These amendments to the ITA added, among other things, the following: 

  • a provision to adjust the transfer pricing quanta and nature of a transaction between non-arm’s length parties to be consistent with arm’s length transaction terms; 
  • a requirement that the taxpayer maintain contemporaneous documentation in respect of any transfer pricing transaction; and
  • the imposition of a 10% transfer pricing penalty.

Additional revisions to the Canadian transfer pricing legislation were subsequently introduced in 2012 to treat a benefit realised by a non-resident obtained from a transfer pricing transaction as a deemed dividend equal to the amount of the benefit conferred on the non-resident, even if that non-resident was not a shareholder of a Canadian corporation (“Secondary Transfer Pricing Adjustment”).

In December of 2016, Canada adopted country-by-country reporting (“CbC Reporting”). Accordingly, if a multinational enterprise (MNE) has gross annual corporate group revenue of at least EUR750 million and a Canadian-resident ultimate parent entity, a Canadian-resident constituent entity, or an appointed surrogate entity, it will be obliged to comply with CbC Reporting rules pursuant to Section 233.8 of the ITA. 

In the 2022 Canadian federal budget, the federal government confirmed its intention to consult on the Canadian transfer pricing rules following a favourable case decided by the Federal Court of Appeal in R v Cameco Corporation. As of the date of this publication, the consultation paper has not yet been released.

The Canadian transfer pricing rules apply to all controlled transactions (ie, cross-border transactions between persons that do not deal at arm’s length with one another). The CRA asserts that the parties to a transaction should not generally be considered to be dealing at arm’s length in a transaction where:

  • there is a common mind directing the bargaining of both parties to the transaction;
  • the parties are acting in concert without independent interests; and
  • one party has de facto control over the other.

Further, paragraph 251(1)(a) of the ITA deems “related persons” to not be dealing at arm’s length with each other, regardless of the actual state of affairs between the related persons. The ITA defines related persons to include, among other things:

  • corporations that are under common control;
  • in the case of two corporations, where one controls the other; and
  • individuals connected by blood relationship, marriage, common-law partnership or adoption.

Canada’s legislation does not expressly identify any transfer pricing methodologies upon which the Canadian taxing authorities will rely. However, the CRA has endorsed the following methods, which were derived from the OECD Guidelines to ensure that transfer prices are consistent with the arm’s length principle.

Traditional transfer pricing methods:

  • the comparable uncontrolled price (CUP) methodology, which compares prices for similar goods or services between arm’s length parties;
  • the resale price methodology, which compares profit mark-ups applied by arm’s length parties on the sale of similar goods that should be paid by the taxpayer to a related party for goods resold to those third parties; and
  • the cost plus methodology, which compares profit mark-ups applied by arm’s length parties to the production of goods or services to determine a sale price which should be charged to the taxpayer for those goods and services.

Profit-based methods:

  • the transactional profit-split methodology, which requires that the parties allocate the profits among themselves that arm’s length parties would have been expected to realise based on certain factors; and
  • the transnational net margin methodology (TNMM), which compares the net profit margin realised by a taxpayer on one or more transactions with related parties with the net profit margin realised by non-arm’s length parties under analogous circumstances.

As discussed under 3.3 Hierarchy of Methods, the ITA does not prescribe a uniform approach to transfer pricing methods. Although the transfer pricing methods articulated in the OECD Guidelines are not specified in the ITA, they are used as an interpretative tool to ensure that transfer prices are consistent with the arm’s length principle.

As discussed above under 3.1 Transfer Pricing Methods, the ITA does not specify the methods which taxpayers must utilise to ensure that transfer prices are consistent with the arm’s length principle. As a result, provided that the taxpayer selects a transfer pricing method that results in an outcome that is reasonable under the circumstances, the ITA does not prohibit the adoption of unspecified transfer pricing methods. 

In TPM-14, the CRA confirmed that it will not attempt to apply a single, uniform method to all transfer pricing transactions. Instead, the focus is to apply  “the most appropriate transfer pricing method to the circumstances of the case”. In that publication, the CRA further stated that the method for selecting the most suitable transfer pricing method should be the method which will “provide the most direct view of arm’s length behaviour and pricing”. 

Nevertheless, the CRA maintains that there is a natural hierarchy among the transfer pricing methodologies. For instance, the CRA and the OECD Guidelines both indicate that the traditional transaction methods, including the CUP method, are preferable to a transactional profit method. Arguably, subsection 247(2) endorses the concept of the CUP method since that approach is the embodiment of the arm’s length principle. 

Rather than strict adherence to this hierarchy, the CRA has confirmed that it is the degree of comparability available under each of the methods and the availability and reliability of the data which will ultimately determine the most suitable transfer pricing method to adopt in any given transaction.

Canada does not impose a strict “statistical measure” requirement on transfer pricing methods, although such measures may be helpful in determining the suitability of certain transfer pricing methods.

Provided that a taxpayer has employed a transfer pricing methodology that has produced a reasonable result, ranges may be used to determine a suitable transfer price and the CRA will not adjust that price. The CRA has confirmed that “[t]he application of the most appropriate transfer pricing methodology may produce a range of results”. 

This administrative position should be welcome to taxpayers because, where the CUP method is not applicable or there are no readily available comparables, a range of results will often be the only method by which the taxpayer can determine an appropriate transfer price. Further, although the CRA has rejected the use of the interquartile range (adopted by the American tax authorities) to narrow the range of acceptable results, in practice, that methodology has been used by the CRA and taxpayers in coming to an appropriate range of results. 

Comparability adjustments are not required under any Canadian legislation or regulation. Conversely, the CRA’s position, as more particularly described in TPM-14, sets forth the position that comparability adjustments must be made where appropriate as long as such adjustments may be completed on a reliable basis. 

Although the CRA’s position accords with the guidance contained in the OECD Guidelines, the disconnect between the ITA and the CRA’s administrative position may generally be resolved in the taxpayer’s favour because the courts have repeatedly held that the OECD Guidelines do not form part of Canadian tax law.

Canada does not have any notable rules respecting the transfer pricing of certain intangibles, and accordingly, general tax law and policies apply to intangibles. For instance, the minister is entitled to tax the gain or income arising from the transfer of an intangible pursuant to Sections 9, 14 or 38 of the ITA, based on the taxpayer’s particular facts and circumstances. In addition, Section 69 of the ITA provides that a disposition of property to a non-arm’s length person must occur at fair market value.

Although Canada has adopted the OECD’s hard-to-value intangibles contained in the OECD Guidelines, it has not amended the ITA to reflect those guidelines.

Historically, with respect to hard-to-value, the CRA takes the position that the use of hindsight to determine the fair market value of a transfer price for intangibles is inappropriate. However, hindsight may be used to allow the CRA to assess the reasonableness of the ex-ante assumptions which the taxpayer relied upon to determine the valuation of the hard-to-value intangible.

The ITA recognises the existence of cost contribution agreements (CCAs) by reference to the definition of “a qualifying cost contribution arrangement” contained in subsection 247(1) of the ITA. That provision defines a “qualifying cost contribution arrangement” (QCCA) as an arrangement under which the participants must share the costs and risks of the agreement in proportion to the expected benefits arising out of the agreement. Of note, where a participant’s contribution to a QCCA is not consistent with their expectation of the benefits to be derived in such an arrangement, participants may adjust their respective contributions by way of a balancing payment.

Where the CRA determines that the participants to a QCCA are not dealing at arm’s length, the CRA may rely on the OECD Guidelines to either adjust the contributions of either party, or disregard part or all of the terms of the CCA. In fact, the CRA’s guidance expressly provides that “[w]here the commercial reality of an arrangement differs from the terms purportedly agreed by the participants, it may be appropriate to disregard part or all of the terms of the CCA”.

If a taxpayer discovers that it has understated its taxable income as a result of a flawed transfer pricing analysis, that taxpayer may seek to remedy that error with an application under the voluntary disclosure program (VDP) or by way of an advance pricing agreement (APA), which is discussed further under 7. Advance Pricing Agreements (APAs). At the outset, the CRA guidance contained in IC-71R6 recommends that taxpayers seek assistance from the Canadian competent authority prior to requesting a transfer pricing adjustment, because self-initiated requests may result in double taxation.

Very generally, the VDP enables taxpayers to request that the Minister of National Revenue (the “Minister”) grant relief from interest and penalties arising from non-compliance with the ITA under certain circumstances. The CRA has confirmed that as of 1 March 2018, any VDP application relating to transfer pricing adjustments or transfer pricing penalties will be referred to the CRA’s Transfer Pricing Review Committee (TPRC). 

With respect to taxpayer-initiated downward adjustments, there are two potential avenues open to taxpayers to request that the CRA permit a downward adjustment on an assessed income tax return, for which the objection period has already elapsed. First, the taxpayer may initiate a request for a reassessment from the Minister despite failing to timeously file a Notice of Objection. A taxpayer requesting this relief must satisfy the conditions set forth in Information Circular IC75-7R3 and obtain the Minister’s approval for the downward adjustment pursuant to subsection 247(10). Second, a company related to the taxpayer may amend a foreign tax return in a jurisdiction outside Canada, and after being assessed by that foreign taxing authority, that taxpayer may request that the CRA provide it with relief from double taxation through the Mutual Agreement Procedure (MAP).

Downward adjustment made in respect of non-treaty countries should be directed to the competent authorities’ division of the CRA.

Canada has a robust treaty network and has concluded a multitude of double tax conventions and other bilateral treaties which enable taxing authorities to share taxpayer information with other jurisdictions. These treaties often include an “exchange of information” provision among the signatories to the treaties, which enables the CRA to share and receive information from a taxing authority of a treaty state.

In general, these tax treaties permit three types of exchanges:

  • spontaneous exchanges where one taxing authority receives information from the other without having first made a request;
  • an exchange pursuant to a specific request; or
  • an exchange pursuant to a spontaneous examination whereby the taxing authorities in both jurisdictions will assent to jointly conduct an audit of an affiliate in each of their respective jurisdictions.

The scope of most exchanges of information are generally limited by tax treaties to the disclosure of information relating to the type of tax actually encompassed in the relevant treaty (eg, taxes on income and capital). However, some treaties, like Article XXVII of the Canada-US Convention, contemplate the exchange of information concerning all taxes imposed by the treaty states. 

Furthermore, in December of 2016, Canada incorporated country-by-country reporting into its domestic law with the introduction of Section 233.8 in Part XV of the ITA.

Canada has a longstanding APA programme designed to assist taxpayers in determining an appropriate transfer pricing method for transactions that they have entered into with non-arm’s length non-resident entities. Canadian-resident taxpayers are under no obligation to propose or conclude an APA: the programme is a voluntary agreement between the Canadian-resident taxpayer and the CRA, which permits the CRA to determine whether the transfer pricing method employed for its current or future cross-border transactions will be compliant with Section 247 of the Act and the arm’s length principle. 

The CRA is entitled to enter into unilateral or bilateral/multilateral APAs with taxpayers; however, bilateral/multilateral arrangements are more widespread. One of the benefits conferred by concluding a bilateral/multilateral agreement with the CRA is minimisation of the potential for double taxation in the event that a foreign taxing authority disagrees with the CRA.

In 2005, the CRA introduced the APA for Small Businesses (“APA-SB”), a programme targeted specifically towards small businesses with an annual gross revenue of less than CAD50 million and where the transfer pricing at issue is less than CAD10 million. The APA-SB programme endeavours to streamline and simplify APA applications for small businesses.

The CRA’s current administrative guidelines in respect of APAs are set forth in Information Circular 94-4R, which the CRA indicated in 2022 will undergo amendments.

The CRA’s APA programme is administered by the Competent Authority Services Division (CASD) of the International and Large Business Directorate of the Compliance Programs Branch. Based on the most recent programme report prepared by the CASD for the year 2021, 30 applicants applied to the APA programme; six new cases were accepted into the programme; and nine APAs were completed. The trend in recent years has been that the majority of APAs concluded have been either bilateral or multilateral in nature, and generally involve at least one other foreign tax administrator.

Both the APA programme and the MAP are ultimately under the jurisdiction of the CASD, and accordingly, there is a high degree of co-ordination between the APA process and the MAP. The CASD is responsible for:

  • the negotiation of disputes with foreign tax administrations regarding double taxation or in instances where taxation is not in accordance with a convention under MAP articles of Canadian tax treaties; and
  • the negotiation of APAs with foreign tax administrations to determine appropriate transfer pricing methods for cross-border transactions undertaken between related parties and to determine the appropriate method to attribute profits to a permanent establishment.

The CRA’s administrative guidance contained in Information Circular IC 94-4R provides that any taxpayer subject to the act’s transfer pricing rules may request an APA. Thus, all transactions involving related parties and agreements between a taxpayer and a non-resident entity may be the subject of an APA.

However, the CRA has suggested that there are instances where it will not entertain an APA request from the taxpayer. These instances include the following circumstances:

  • any APA request involving single transactions, which include the transfer of intangible assets;
  • any APA request pertaining to the restructuring of a business; and
  • any APA request concerning issues which are currently before the courts.

Applicants applying to the APA-SB are limited to seeking an APA on a unilateral basis.

In general, a pre-filing meeting with the CRA should be held 180 days after the year-end of the first taxation year to be covered by the proposed APA. Although an APA can have retroactive effect, the taxpayer may only request that an APA be rolled back to non-statute-barred taxation years.

The CRA is entitled to impose user charges on taxpayers making a request for APAs for “out-of-pocket” expenses incurred by the CRA in evaluating and negotiating the APA request. These can include the cost of travel, food, etc, but generally do not include the cost of staff time. Any user charges will be contained in the APA acceptance letter issued to the taxpayer by the CRA and these are due upon reply by the taxpayer to the APA acceptance letter.

In contrast, an application to the APA-SB requires payment of a non-refundable administrative fee of CAD5,000, which accords with the programme’s goal to provide a cost-effective and simple process for small businesses.

The CRA states that the length of an APA is usually from three to five years. Although the five-year term has become the norm, the duration of each APA will vary depending on the facts and circumstances of the particular case. When making an APA request, taxpayers must propose an initial term for the APA which is acceptable to the CRA.

In some instances, an APA may have retroactive effect and be “rolled back” to apply to prior, non-statute-barred years. Taxpayers should note that roll-backs are available only for those requesting a bilateral or multilateral APA, and the roll-backs are not permissible for unilateral APAs pursuant to TPM-11.

The CRA cautions that the retroactive application of an APA will apply only when the facts and circumstances of the prior years were similar to those on which the APA was eventually concluded. To determine whether a roll-back is appropriate, the CRA will consider the following four criteria:

  • a request for contemporaneous documentation has not been issued by a tax services office (TSO);
  • the facts and circumstances are the same;
  • the foreign tax administration and the relevant TSO have both agreed to accept the APA roll-back request; and
  • appropriate waivers pursuant to subparagraph 152(4)(a)(ii) have been filed.

Transfer Pricing Penalties

Subsection 247(3) articulates the penalty provisions of the ITA (the “Transfer Pricing Penalty”) which are aimed at encouraging greater compliance with the Canadian transfer pricing rules. From a high-level perspective, the Transfer Pricing Penalty may be applicable where the CRA proposes transfer pricing adjustments that exceed the lesser of CAD5 million or 10% of the Canadian taxpayer’s gross revenue for the year.

Where the Transfer Pricing Penalty is applicable to a taxpayer, then the minister is entitled to generally assess the equal of 10% of the following:

  • the sum of the total transfer pricing capital adjustments and total transfer pricing income adjustments; minus 
  • the total of all transfer price adjustments (including negative adjustments) which pertain to the transactions where the Canadian-resident taxpayer made reasonable efforts to determine and use arm’s length transfer prices (the “Net Adjustment”).

In sum, the CRA may impose a Transfer Pricing Penalty pursuant to subsection 247(3) of the ITA if the transfer pricing adjustment exceeds CAD5 million or if the Net Adjustment is 10% greater than the taxpayer’s gross revenue, and the relevant taxpayer has not made reasonable efforts to determine and use arm’s length prices in transactions with a non-arm’s length non-resident.

Furthermore, where a transfer pricing adjustment applies, the Canadian-resident taxpayer may be subject to a secondary adjustment (the “Secondary Transfer Pricing Adjustment”) for withholding tax under part XIII of the act on an over/underpayment as applicable. If the taxpayer has not withheld tax at the relevant time, then subsection 227(8) of the ITA will impose a penalty on the Canadian-resident taxpayer for amounts which were not properly withheld.

Defences to Transfer Pricing Penalties

The taxpayer’s best recourse to avoid the imposition of penalties under subsections 247(3) and (8) of the ITA is to prove that it has made reasonable efforts to determine and use arm’s length prices in accordance with the arm’s length principle. The CRA acknowledges in TPM-09 that transfer pricing is “not an exact science”, and accordingly, it utilises an objective standard for determining whether the taxpayer made reasonable efforts to comply with the arm’s length principle.

More precisely, the CRA will evaluate whether the degree of effort employed by the taxpayer was that of an independent and competent person engaged in the same line of business or endeavour would exercise under similar circumstances with regard to the complexity and particular circumstances of the taxpayer’s situation.

Significantly, where a taxpayer fails to retain and produce contemporaneous documentation related to the subject transactions, the ITA will deem that the taxpayer has not made reasonable efforts and the taxpayer will likely be subject to penalties.

Canadian-resident taxpayers are not required to compile and file an OECD master file or a local file for Canadian transfer pricing purposes. The transfer pricing documentation requirements prescribed by legislation are contained in subsection 247(4) of the ITA. These documents must be prepared by the date that the taxpayer files its income tax return, but documentation is only required to be submitted to the CRA within three months of a written request being served by the CRA on the Canadian-resident taxpayer.

Moreover, Canada has adopted and codified the country-by-country reporting requirements set out in the OECD Guidelines which are contained in subsection 233.8(3) of the ITA. This provision requires that Canadian-resident corporate taxpayers that are subject to the transfer pricing rules must file a country-by-country report (“CbC Report”) in the prescribed Form RC4649. This form mirrors the model CbC Report template proposed by the OECD.

The Canadian transfer pricing rules and the CRA’s administrative guidance are broadly aligned with the OECD Guidelines. Commencing with the 1995 OECD Guidelines, the Department of Finance has confirmed that the OECD Guidelines will form the basis of the government’s review of its transfer pricing practices and the CRA’s assessing policies. 

For instance, the CRA has endorsed the guidance articulated in the OECD Guidelines in respect of the arm’s length principle, transfer pricing methods and the hierarchy contained therein; intangible transfers; and attribution of profits to permanent establishments, and its assessing policies generally reflect the positions outlined in the OECD Guidelines.

However, the Supreme Court of Canada in GlaxoSmithKline v R, 2012 SCC 52 held that while the methodology and commentary contained in the OECD Guidelines may be helpful in determining the appropriate transfer price for any given transaction or series of transactions, ultimately, the appropriate transfer price must be determined in accordance with the provisions of the act. In effect, although the OECD Guidelines are not legally binding, taxpayers may rely on the commentary therein as interpretive aids for the relevant ITA provisions.

Canada has adopted the arm’s length principle and this commitment was codified into law in subsection 247 of the ITA. As a result, the Canadian transfer pricing rules do not permit deviation from the arm’s length principle. See 2.1 Application of Transfer Pricing Rules for a discussion of the Canadian domestic law and administrative guidance in respect of an arm’s length relationship.

Canada is a signatory of the OECD’s BEPS project, the OECD’s agreements in respect of transfer pricing and more than 90 income tax treaties, which include MAPs. There are generally four actions set forth under the OECD’s 2013 Action Plan on Base Erosion and Profit Sharing (the “Action Plan”) which pertain to transfer pricing:

  • Action 8 – which relates to intangibles;
  • Action 9 – which relates to risk and capital;
  • Action 10 – which relates to high-risk transactions; and
  • Action 13 – which relates to documentation and country-by-country reporting.

As discussed, the CRA has consistently endorsed the OECD Guidelines in its assessing policies, and legislative amendments to the ITA have been made to reflect certain guidance contained in the OECD Guidelines. Accordingly, the BEPS project has been inserted into both Canada’s domestic law and its administrative guidance.

Canada is a signatory of the OECD/G20’s Inclusive Framework on Base Erosion and Profit Shifting eight-page statement in respect of the two pillar framework. The impact of Pillar One on Canada’s domestic taxing legislation can already be seen with the introduction of the proposed Digital Sales Tax Act (DSTA). Broadly, the DSTA would impose a 3% tax on certain revenue earned by large businesses (both domestic and foreign) from select digital services and the sale or licensing of certain Canadian user data. 

The Canadian government expressed its “strong preference” for a multilateral approach to responding to the challenge of taxing the digital economy (as discussed in Pillar One). Accordingly, if the BEPS 2.0 initiatives do not bear fruit in the form of a multilateral agreement, the federal government has signalled that the DSTA will come into effect on 1 January 2024.

Subsection 247(7.1) of the act provides an exemption for fees paid by a Canadian-resident corporation for loan guarantees provided to a non-resident subsidiary controlled corporation. As a result, transfer pricing adjustments will not apply pursuant under subsection 247(2) to any consideration paid or payable to a parent Canadian-resident corporation if it provides a guarantee for the repayment, in whole or in part, of an amount owing to a non-resident controlled subsidiary, provided that the following apply:

  • the non-resident person is a controlled foreign affiliate of the parent Canadian-resident corporation for the purposes of Section 17 of the ITA in the period that the amount is owing; and
  • the parent Canadian resident corporation establishes that the particular amount would be an amount described in paragraphs 17(8)(a) or (b) of the ITA if that amount were owed to the parent.

The UN Practical Manual on Transfer Pricing (the “UN Manual”) has limited impact on transfer pricing or enforcement in Canada. As previously discussed, Canada relies on the provisions of the ITA, the CRA’s administrative guidance and assessing policies, and the guidance contained in the OECD Guidelines to shape its approach to transfer pricing – the UN Manual has very limited application.

In or around 2000, there was a debate as to whether the CRA’s transfer pricing auditors had adopted a safe harbour in reassessing certain licensing transactions. More particularly, it has been reported that the CRA auditors (with the approbation of the CRA’s International and Large Business Directorate) would issue final reassessments that allocated a 75/25 split of the profits between a licensee and licensor in a transfer pricing arrangement. In response to enquiries requesting that the CRA confirm the existence of this safe harbour practice, the CRA definitively disavowed that it would employ any safe harbours for transfer pricing purposes in two administrative publications.

Accordingly, Canada does not employ or endorse any transfer pricing safe harbours, nor does any legislative guidance exist respecting safe harbours in the transfer pricing context. Notwithstanding certain loan guarantees provided by a Canadian-resident parent to its controlled foreign affiliate and other loans described in Section 17 of the ITA, the transfer pricing rules will apply to transactions between a Canadian-resident taxpayer and a non-resident with whom the Canadian taxpayer deals at non-arm’s length.

Canada does not have specific rules which apply to location savings or other location-specific attributes.

In general, Canada’s transfer pricing policies are aligned with those set forth in the OECD Guidelines.

However, one of the notable rules contained in Canada’s transfer pricing policies is the ability of the CRA to re-characterise a transaction when the transaction is either (i) a sham; or (ii) would not have been entered into between persons dealing at arm’s length, and where it can reasonably be considered that the transaction was not entered into primarily for a bona fide purpose other than to obtain a tax benefit.

In cancelled Information Circular IC-872R, the CRA took the position that it was under no obligation to accept the established or reported value for the duty when determining the income tax implications for a transfer pricing arrangement. As a result, Canada does not necessarily require co-ordination between the transfer pricing and customs valuation. However, the Canada Border Services Agency (CBSA) confirmed that transfer pricing adjustments may be retroactively implied to reduce customs importation duties where an upward or downward transfer pricing adjustment in the relevant fiscal period is identified.

The methodology used to compute the value for duty under Canada’s Customs Act largely resembles those transfer pricing methodologies proposed by the OECD Guidelines and endorsed by the CRA. For instance, Section 47 of the Customs Act establishes an ordering hierarchy of valuation methodologies to be used:

1. the transaction value of identical goods; 

2. the transaction value of similar goods;

3. the deductive value of goods;

4. the computed value of the goods; and lastly,

5. where none of the above-mentioned methodologies are applicable, a mixed approach pursuant to Section 53 of the Customs Act.

The transaction value for customs purposes corresponds with the CUP method in transfer pricing; the deductive value resembles the resale price method; and the computed value corresponds with the cost-plus method. 

Accordingly, although the CRA does not require that the transfer pricing and customs valuation align, the methodologies used to determine the appropriate value for both are largely the same. 

Subsection 247(11) provides that the same ITA provisions which govern the timing, assessments, payments, refunds, penalties, interest, objections and appeals under Part I of the ITA will apply to the transfer pricing rules set forth in part XVVI.1 of the ITA.

Transfer Pricing Audit

A Canadian transfer pricing audit is a multi-staged process, which is often time-consuming and invasive. Generally, transfer pricing audits commence formally when the CRA makes a request for contemporaneous documentation for the subject transactions. Once the auditor has analysed and considered all the materials provided by the taxpayer, the auditor will issue a proposal letter, which will include a copy of the CRA’s transfer pricing penalty report, where a Transfer Pricing Penalty has been recommended. The proposal letter will generally afford the taxpayer 30 days to respond (subject to extensions) and provide the taxpayer with the opportunity to make representations. If the taxpayer’s representations do not change the auditor’s view, then they will issue a final letter confirming or varying the proposal letter. A Notice of Reassessment will follow.

Administrative Appeal

If the taxpayer disagrees with the Notice of Reassessment, the taxpayer is entitled to file a Notice of Objection or submit a competent authority assistance request pursuant to the relevant tax treaty. The taxpayer may take both approaches; however, the Notice of Objection will be held in abeyance pending the competent authority request.

Where the taxpayer is a “large corporation” as defined by the ITA, the filing of the Notice of Objection requires the payment of half of the assessed tax owing. The CRA may accept security for the transfer pricing amounts in dispute. The vast majority of transfer pricing disputes will come to a resolution at either the audit or objections phase.

Judicial Process (Trial and Appeal)

If the taxpayer is unsuccessful in persuading the minister to vacate the Notice of Reassessment, the minister will issue a Notice of Confirmation. The taxpayer then has the opportunity to file a Notice of Appeal to bring the matter before the tax court of Canada for review by a judicial body. If the taxpayer receives an unfavourable decision at the tax court, then any appeal would be to the Federal Court of Appeal. Should the taxpayer receive another unfavourable decision from that judicial body, the taxpayer may make an application for leave to appeal to the Supreme Court of Canada. 

The law involving transfer pricing disputes in Canada has not been thoroughly developed because most transfer pricing disputes are resolved in the audit or objection stage. Relevant judicial decisions are described below under 14.2 Significant Court Rulings

Unfortunately, given the context and fact-driven nature of almost all transfer pricing disputes, the factual matrix of a taxpayer’s particular circumstances may make it difficult to rely on precedents which are factually dissimilar. 

A number of landmark decisions have been reached in the transfer pricing context in Canada. 

  • General Electric Capital Canada Inc v R, 2010 FCA 344 (Federal Court of Appeal): holding that “implicit support” is a factor an arm’s length party may find relevant in pricing a guarantee fee between a Canadian-resident subsidiary and its US-parent company.
  • GlaxoSmithKline Inc v R, 2012 SCC 52 (Supreme Court of Canada): holding that courts must consider the “economically relevant characteristics” of both arm’s length and non-arm’s length corporations when applying the arm’s length principle. The court further held that the transfer price of any transaction or series of transactions must be determined in accordance with the provisions of the ITA, and not only by reference to the methodology or commentary proposed in the OECD Guidelines.
  • Cameco v R, 2020 FCA 112 (Federal Court of Appeal): holding that a transaction may only be subject to recharacterisation if no arm’s length party would have entered into that transaction or series of transactions. The court referred to the OECD Guidelines for two instances in which taxing authorities would be entitled to ignore the transfer pricing structures put in place by taxpayers – (i) where the structure of the transaction, viewed in its totality, differs from those which would have been adopted by independent enterprises, or (ii) where the structure would impede the taxing authority’s ability to determine an appropriate transfer price. 

Canada’s transfer pricing rules do not restrict outbound payments relating to uncontrolled transactions.

Canada’s transfer pricing rules do not restrict outbound payments relating to controlled transactions.

Unlike some of Canada’s treaty partners (eg, the United States), Canada’s transfer pricing rules are silent as to the effects of other countries’ legal restrictions.

The CASD publishes annual reports respecting applications to the APA programme in the aggregate. Details pertaining to the applicants of the APA programme are not made available to the public. Taxpayers should be aware that any information provided to the CASD in the course of the APA negotiations may be considered by the taxing authorities as received for the purpose of administering the act. As a result, that information could be used by the CRA to reassess the taxpayer for other income sources and taxation years unrelated to those set forth in the APA.

The CRA takes the position that it is entitled to use “secret comparables” in the context of transfer pricing enforcement. In cancelled Information Circular IC 87-2R, the CRA indicated that it may use secret comparables derived from third-party comparable information to form the basis of an assessment in isolated cases. In these circumstances, the CRA will refuse to disclose the source of the secret comparable unless and until the matter proceeds to a legal proceeding, where such information becomes subject to disclosure. In the audit and objection stages, the CRA will generally refuse to disclose the source of the secret comparables.

In TPM-04, the CRA discusses the use of secret comparables, which it refers to under the moniker “confidential third-party information” in transfer pricing audits. In that publication, the CRA cites four competing interests for the use of “confidential third-party information” in the context of a transfer pricing audit:

  • the interest of the CRA to use the most reliable data to determine an arm’s length price in transfer pricing audits;
  • the interest of the taxpayers to know the facts and assumptions on which the CRA relies to formulate an assessment;
  • the interest of third parties to not have their confidential information disclosed in the course of a transfer pricing audit; and
  • the interest of Canada’s treaty partners that the CRA should not use secret comparables, so that the treaty partners have common ground to mitigate double taxation during the competent authority process.

The CRA purports to only use secret comparables as a method of last resort to form the basis of an assessment. Where a CRA auditor elects to use secret comparables, they must refer the file to the International Tax Operations Divisions.

It is premature to definitively state the effect the COVID-19 pandemic has had on the transfer pricing landscape in Canada. 

During the pandemic, the CRA affirmed its guidance in TPM-17, which states that government assistance received by Canadian-resident taxpayers should generally be treated as a market condition. The CRA further stated that it would contravene the arm’s length principle to assume that the receipt of government assistance would affect the transfer prices. Nevertheless, the CRA has stated that taxpayers who have received Canadian government assistance, such as the Canada emergency wage subsidy, would retain those government subsidies and avoid sharing with other non-arm’s length entities. This area could be ripe for audit in the coming years. 

The pandemic’s impact on transfer pricing will no doubt become more obvious in the years to come.

The Canadian government did not relieve taxpayers from their payment obligations or relax its standards in relation to transfer pricing during the pandemic.

Transfer pricing audits continued during the course of the pandemic, although the CRA did experience delays as it worked through its backlog. Unfortunately, public data with respect to the progress of audits during the pandemic has not been made readily available by the CRA. But taxpayers can rest assured that the CRA continues to commence new transfer pricing audits and conclude existing ones. 

Miller Thomson LLP

Scotia Plaza
40 King Street West
Suite 5800
Toronto
ON M5H 3S1
Canada

+416 595 8626

+416 595 8695

dchodikoff@millerthomson.com millerthomson.com/en
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Trends and Developments


Authors



Miller Thomson LLP is a national business law firm with approximately 525 lawyers across five provinces in Canada. The firm offers a full range of services in litigation and disputes, and provides business law expertise in mergers and acquisitions, corporate finance and securities, financial services, tax, restructuring and insolvency, trade, real estate, labour and employment, as well as a host of other specialist areas. Clients rely on Miller Thomson lawyers to provide practical advice and good value. The firm has close to 60 tax practitioners, with its transfer pricing lawyers primarily located in its Vancouver, Calgary, Toronto and Montreal offices. From planning to controversy, the firm’s transfer pricing lawyers have advised multinational companies in numerous sectors, including but not limited to, automotive, forestry, telecommunications, pharmaceuticals, software, business management, fashion, and banking and finance.

The Rise in Court Intervention in Transfer Pricing Disputes

There are more transfer pricing disputes making their way to court in Canada. Here, transfer pricing disputes have been primarily resolved through one of two methods: a request for Competent Authority assistance under the Mutual Agreement Procedure (MAP) of a treaty or by way of a Notice of Objection filed with the Canada Revenue Agency (CRA) in respect of the Notice of Assessment or Reassessment.

In circumstances where taxpayers cannot have their matter adequately resolved at the Notice of Objection stage, taxpayers have increasingly pressed their cases to the tax court of Canada for resolution. The tax court functions as a trial court, with all that implies. A taxpayer can appeal a decision of the tax court to the Federal Court of Appeal. A further appeal to the Supreme Court of Canada is possible. However, the taxpayer must first file a leave application and the Supreme Court may grant leave or dismiss the application.

The OECD Transfer Pricing Guidelines

It is important to keep in mind that Canada, as a member of the Organisation for Economic Co-operation and Development (OECD), fully endorses the OECD Transfer Pricing Guidelines. For instance, the Canadian taxing authority affirms that the arm’s length principle should be the prevailing approach to transfer pricing.

Consequently, Canada’s published administrative guidelines reflect the guidance provided in Chapter II of the OECD’s Transfer Pricing Guidelines. In Canada, there is a preference for domestic comparables over foreign comparables. It is true, however, that foreign comparables are acceptable provided that such comparables meet identical standards of comparability. It is interesting to note that the CRA does use secret comparables for transfer pricing assessments but this is not the common practice.

Existing legislation and developments

It would be a mistake to conclude that in Canada the transfer pricing rules operate in a vacuum. Put simply, there are a number of sections in Canada’s income tax legislation and regulations that deal with the tax treatment of intangibles, assets and expenses in relation to services. While Canada does not have specific legislation related to the transfer pricing of financial transactions, Canada does have rules related to thin capitalisation and, more generally, the tax treatment of financial transactions. Moreover, the federal government has proposed new rules that come into force in 2023 that are designed to limit the deduction of interest and are in line with the recommendations of the OECD’s base erosion and profit shifting (BEPS) Action 4 Report. Canada has also introduced anti-hybrid rules that are consistent with the OECD’s BEPS Action 2 recommendation.

An increase in audits

These recent legislative developments and the increasing number of cases heading to the courts point to the reality that the Canadian federal government is spending more resources on auditing transfer pricing activities and making it tougher on companies to meet compliance requirements.  Now, it makes very good sense for companies involved in transfer pricing matters to be proactive on the defence front in order to ensure that if the CRA comes knocking with an audit, companies are properly and fully prepared to respond. This early audit protection approach has served our multinational clients exceptionally well and has effectively limited the time, cost and energy needed to respond to such CRA audits.

The COVID-19 pandemic may be one explanation as to why there has been an increase in audit activity by the Canadian taxing authorities. The financial ramifications of the COVID-19 pandemic continue to persist. For example, like many countries affected by the outbreak of the pandemic, the Canadian federal government increased spending to implement new measures to respond to the pandemic. Significant spending has, in turn, led to significant deficits. Some commentators have suggested that tax audits, and transfer pricing audits specifically, will be an area of focus for the federal government and the Canada Revenue Agency.

Miller Thomson LLP

Scotia Plaza
40 King Street West
Suite 5800
Toronto
ON M5H 3S1
Canada

+416 595 8626

+416 595 8695

dchodikoff@millerthomson.com millerthomson.com/en
Author Business Card

Law and Practice

Authors



Miller Thomson LLP is a national business law firm with approximately 525 lawyers across five provinces in Canada. The firm offers a full range of services in litigation and disputes, and provides business law expertise in mergers and acquisitions, corporate finance and securities, financial services, tax, restructuring and insolvency, trade, real estate, labour and employment, as well as a host of other specialist areas. Clients rely on Miller Thomson lawyers to provide practical advice and good value. The firm has close to 60 tax practitioners, with its transfer pricing lawyers primarily located in its Vancouver, Calgary, Toronto and Montreal offices. From planning to controversy, the firm’s transfer pricing lawyers have advised multinational companies in numerous sectors, including but not limited to, automotive, forestry, telecommunications, pharmaceuticals, software, business management, fashion, and banking and finance.

Trends and Developments

Authors



Miller Thomson LLP is a national business law firm with approximately 525 lawyers across five provinces in Canada. The firm offers a full range of services in litigation and disputes, and provides business law expertise in mergers and acquisitions, corporate finance and securities, financial services, tax, restructuring and insolvency, trade, real estate, labour and employment, as well as a host of other specialist areas. Clients rely on Miller Thomson lawyers to provide practical advice and good value. The firm has close to 60 tax practitioners, with its transfer pricing lawyers primarily located in its Vancouver, Calgary, Toronto and Montreal offices. From planning to controversy, the firm’s transfer pricing lawyers have advised multinational companies in numerous sectors, including but not limited to, automotive, forestry, telecommunications, pharmaceuticals, software, business management, fashion, and banking and finance.

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