Arms-length prices, when possible, are set based on
observable market transaction information. The OECD's Transfer
Pricing (TP) Guidelines for Multinational Enterprises and Tax
Administrations outline five comparability factors that should
be considered in evaluating whether third-party transactions
are adequately comparable to the related-party transaction.
These include two which are particularly interesting:
- The economic circumstances of the parties;
- The business strategies of the parties in
relation to the controlled transaction.
Given the volatility, structural changes and market dynamics
at play within and around the Canadian oil and gas (O&G)
industry, the focus by taxpayers and tax authorities on
economic circumstances and evolving business strategies will
likely become more important in the establishment of TP for
oil, natural gas and liquefied natural gas (LNG).
Canada's O&G industry
The Canadian O&G industry finds itself at a crossroads,
facing challenges for which there are no clear, short-term
solutions. Significant events during the latter half of 2018
illustrate the malaise the sector has suffered since the
beginning of the most recent sectoral downturn (which commenced
in late 2014).
Changes in oil sands ownership
In late 2017 and early 2018, powerhouse European
multinationals divested oil sands assets and focused on natural
gas and/or other investment opportunities globally. These
traditional powerhouses were largely replaced by Canadian
energy companies and Asian national oil companies (NOCs).
Oil pipeline constraints
While much of the world saw a moderate strengthening and
stabilisation of oil prices in 2018, Canadian oil was subject
to increased volatility. In the final quarter of 2018, Canada
experienced an imbalance between crude inventories and export
capacity (primarily pipeline capacity). This led to a
significant discount on Canadian heavy crude relative to US and
worldwide crude prices (see Figure 1).
In Q4 2018, Canadian heavy crude traded at near historically
high discounts to the West Texas Intermediate (WTI) benchmark.
This ultimately led to Alberta's government initiating
mandatory crude oil production curtailment from January 2019.
These curtailments are expected to reduce production by 325,000
bbl/d until inventories return to normal historical levels.
It is expected that trains will provide additional transport
capacity, but not at the levels needed. While production cuts
are expected to reduce (but not eliminate) the pricing
differential through 2019, they will also likely depress
drilling activity. The persistent uncertainty surrounding
pipeline approval will leave Canadian oil producers with excess
inventories stranded due to insufficient pipeline capacity for
the foreseeable future.
As a result, over the near term, Canadian oil producers are
likely to face significant volatility, higher-than normal price
differentials, and depressed pricing for Canadian
Source: EIA at www.eia.gov/dnav/pet/pet_pri_spt_s1_m.htm,
and Government of Alberta at economicdashboard.alberta.ca/OilPrice
Natural gas sector
Canada's natural gas pricing outlook is more positive, but
experts continue to predict depressed pricing and volatility,
even as North American and global supply chains come
In the last quarter of 2018, US natural gas prices
strengthened over increased demand and reduced storage
capacity. The North American LNG industry will certainly
contribute to demand, and is already driving Canadian gas
exports to the US.
While Canadian gas prices have increased over the second
half of 2018, pricing continues to lag behind the Henry Hub
benchmark. As a result, relatively affordable Canadian gas will
continue to be attractive to the US.
However, national production curtailments in 2019 could
dampen demand for Canadian natural gas, given that Alberta's
oil sands producers utilise approximately 40% of Alberta's gas
Meanwhile, the economic outlook is forecast to slow down in
Europe and Japan, and a softening in demand for hydrocarbons
from China will keep natural gas pricing volatile.
Canadian natural gas producers may be finding advantages in
being able to deliver gas to different markets, allowing them
to capture various pricing opportunities. However, the outlook
for the Alberta Energy Company (AECO) benchmark price continues
to be lower in the medium term.
The headline story for Canadian natural gas in 2018 revolved
around LNG Canada receiving approval. The project will enable
Canadian gas producers to sell and deliver LNG to customers in
Asia and worldwide, finally bringing much-needed market options
to Canadian producers. As a result, the North American LNG
industry will be fascinating to watch over the next five to 10
years, while the Canadian energy industry will continue to
examine its relationship with the US market because of recent
tax reform initiatives.
Transfer pricing landscape
Canada's O&G sector presents a few attributes that may
inform, or otherwise influence, the determination of reasonable
arm's-length prices for cross-border intercompany flows of
hydrocarbon commodities (such as market access, capital flight,
re-domestication and consolidation of upstream assets, historic
differentials). It seems sensible for Canadian taxpayers and
the Canada Revenue Agency (CRA) to account for such
circumstances, bearing in mind the prevailing TP law and
relevant administrative guidance.
Canada's domestic legislation does not contain specific
rules or guidance on how transfer prices ought to be determined
for intercompany commodity flows. The same is true for many
OECD members. Instead, the general TP law provided in section
247 of the Canadian Income Tax Act (ITA), as interpreted by
jurisprudence, governs such transactions.
However, the ITA is silent on how to carry out the TP
analysis contemplated in subsection 247(2). Simply reading the
statute will not provide sufficient guidance on whether it is
prudent to contemplate such economic circumstances, or to what
extent. Thankfully, Canadian courts have dealt with the matter
in several decisions. Canadian TP analysis requires
consideration of all characteristics and circumstances
(economic or otherwise) that are relevant and have bearing on
the price in any given case. It is clear that a proper
analysis, by necessity, is heavily fact-driven and
While the OECD's TP guidelines lack the force of law in
Canada, the CRA endorse the guidelines, and they provide
practical guidance on the application of the TP analysis
required under the ITA.
Accordingly, the prevalent economic circumstances of the
Canadian O&G sector, and the business strategies employed
by the actors that operate in that market, should have a
directional bearing on TP analysis associated with commodities,
both in terms of accurately delineating a particular
transaction and in the context of performing comparability
analyses (OECD TP guidelines, paragraphs 1.110–1.113
and 3.7, July 2017).
Role of the parties involved
Canadian courts have affirmed that the roles, functions, and
interests of the parties to a particular transaction should be
kept in mind when conducting TP analysis. Practically, it is
also important to pay attention to the expanded process in the
revised Chapter 1 of the OECD's TP guidelines.
However, recent Canadian jurisprudence suggests that firms
bearing contractual risk will be entitled to the resulting
profit or loss (for Canadian TP purposes, it is currently not
critical that a firm directly employs the individuals that
manage a particular risk).
Canadian statute does not mandate the use of any specified
TP method (or provide a hierarchy of methods), but courts seem
to indicate a preference for traditional transaction methods
that directly test the price of the transactions undertaken.
Administratively, the CRA's published guidance reflects the
OECD TP guidelines and subscribes to the notion of selecting
the most appropriate method based on the degree of
comparability, and the availability and reliability of
It should be noted that the OECD's 2014 discussion draft on
the TP of cross-border commodity transactions endorsed the use
of the comparable uncontrolled price (CUP) method, and quoted
prices as the most appropriate method for pricing commodity
Several stakeholders responded to the OECD's request for
comments on the discussion draft publicly, suggesting that the
CUP method may often be appropriate (at least as a starting
point to the analysis), but that other TP methods should be
considered and, depending on the applicable facts, used. This
is particularly true in light of the complex, often vertically
integrated, value chains that are commonplace in the
Future pricing strategies
First, it is prudent to clearly distinguish between
pure-play producers, traders (that may be vertically
integrated), and those that use hydrocarbon commodities within
a fully or partially integrated supply chain (e.g. LNG
proponents or integrated O&G). Business strategies and
effects of economic circumstances in the sector will vary for
these players, and appropriate TP strategies should not ignore
In the case of a Canadian E&P selling crude to other
members of the industry value chain (e.g. traders or
processors/refiners) through a foreign related intermediary
(considered commonplace given the prominent trade direction),
the CUP method could be considered. In a very simple fact
pattern, one can base such an approach on a price index, or
perhaps on an actual internal or external CUP with appropriate
comparability adjustments (for example, for quantity,
quality/blend, and delivery terms).
However, given the prevalent economic circumstances, it is
important to avoid inadvertently shifting (or trapping) the
volatile effects of price risk outside the jurisdiction where
it functionally and contractually belongs.
In the event that either party (or both) mitigates price
risk exposure through hedging, it is necessary to evaluate
whether contractual allocation of hedging gains and losses
through the International Swaps and Derivatives Association
(ISDA) master agreements, mirror ISDA agreements or similar
arrangements are required.
Canadian players with more globally interconnected and
vertically integrated supply chains may also consider adopting
alternative pricing models, such as the profit split method
(PSM), either as a primary method or as corroborative evidence
of arm's-length outcomes that are well aligned with assumption
of risk and value creation.
However, the relative importance of producing, storing,
upgrading, transporting and trading/optimising may have shifted
in light of the economic circumstances. Accordingly, careful
consideration of what exactly creates value, who contributes
(owns), and the appropriate bargaining strength of the parties
must be given in view of how arm's-length parties behave in the
With the emphasis on a more disciplined application of the
CUP method and indices, taxpayers are likely to face more
rigorous TP audits and tax authority disputes regarding the
relative merits of selected indices, transaction dates and
computation of adjustments.
Disagreements between tax authorities may arise around
debates over economic circumstances, which call into question
what profit or loss potential should be attributed to
contractual risk versus economic risk, and the functions that
control such risks. Taxpayers seeking certainty may therefore
access the Canadian advance pricing agreement (APA) programme
with more regularity.
Given the depressed pricing environment for hydrocarbon
commodities in Canada, more Canadian players are likely to seek
out international markets. The burgeoning Canadian LNG
industry, which is today focused on Asia, is a good example of
this. As business models and strategies change accordingly, TP
policies will need to keep pace.
© 2019. For information, contact Deloitte Touche
Tohmatsu Limited.This communication contains
general information only, and none of Deloitte Touche Tohmatsu
Limited, its member firms or their related entities
(collectively, the "Deloitte network") is, by means of this
communication, rendering professional advice or services.
Before making any decision or taking any action that may affect
your finances or your business, you should consult a qualified
professional adviser. No entity in the Deloitte network shall
be responsible for any loss whatsoever sustained by any person
who relies on this communication.
Tel: +1 403 267 0665
Andreas Ottosson is a tax partner with Deloitte LLP
in Calgary, and is the Canadian transfer pricing leader
for the oil and gas industry. With well over a decade
of professional experience in TP, Andreas assists a
broad spectrum of established and emerging
multinationals, often within the upstream and midstream
sectors of the oil and gas industry.
Andreas's work involves planning, developing and
documenting strategic and dynamic cross-border
transaction solutions and TP models. He also
specialises in pricing models for intercompany loans,
guarantee fees and hedging activities.
Andreas also assists clients with tax authority
audits on a wide range of TP matters, and helps clients
navigate through recourse avenues.
Tel: +1 403 267 1859
Markus Navikenas is a partner with Deloitte LLP, and
the tax leader for Canada's west region. He also leads
the Canadian E&R tax industry team.
Markus advises many of the world's largest
multinationals in the energy sector. He is sought as a
speaker to industry and tax organisations across North
America. His expertise spans assisting client's with
developing innovative transfer pricing strategies,
negotiating tax authority dispute resolutions, and
aligning TP models with commercial objectives. He is
routinely recognised as one of the world's top TP
advisors. Markus has a passion for working with
companies to find innovative ways to create value in
terms that resonate with his clients.