Canada enacted new transfer pricing rules on March 26 2026, which are applicable to taxation years and fiscal periods that begin after November 4 2025. While the Canada Revenue Agency (CRA) endorsed the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (the OECD Guidelines) prior to the enactment, they did not form part of the country’s transfer pricing legislation. After March 26, the OECD Guidelines are now explicitly incorporated into Canadian law.
Background and key changes
In Canada, transfer pricing is governed by Section 247 of the Income Tax Act (the Act).
Under subsection 247(2) of the new transfer pricing rules, the CRA may effect an adjustment if two requirements are both met:
A taxpayer and a non-resident non-arm’s-length person are participants in a transaction or series of transactions; and
The transaction includes actual conditions that are different from the conditions that would exist in a transaction between arm’s-length parties.
This rule consolidates the prior ‘repricing’ rule in old paragraphs 247(2)(a) and (c) and the prior ‘recharacterisation’ rule in old paragraphs 247(2)(b) and (d) into a single transfer pricing test.
There is a new substance-based test under subsection 247(1.1). This specifies that a transaction or series is to be analysed and determined with reference to the ‘economically relevant characteristics’. These include the following:
The contractual terms.
The actual conduct of the participants, and, in particular, the functions performed by the participants, taking into account:
The assets and risks assumed;
The relationship of those functions to the value generated by the multinational enterprise (MNE) group as a whole;
The circumstances surrounding the transaction or series; and
Industry practices.
The characteristics of any property transferred or service provided.
The economic circumstances of the participants and the market in which the participants operate.
The business strategies pursued by the participants.
In effect, the addition of the ‘economically relevant characteristics’ definition creates an economic substance test in the transfer pricing rules under the Act, in line with the OECD Guidelines.
There is also a new subjective comparison test due to the recently enacted definition of ‘arm’s-length conditions’ in subsection 247(1). In effect, taxpayers must now demonstrate that they would have entered into the transaction(s) in question with a non-resident non-arm’s-length party, as opposed to drawing a comparison between other similar entities or hypothetical persons.
The addition of the subjective comparison test is in response to the Federal Court of Appeal decision in Canada v Cameco Corporation (2020), wherein the court determined that the arm’s-length principle required consideration of hypothetical arm’s-length parties in a transfer pricing comparison, without taking into account the economic and commercial context of the particular non-arm’s-length taxpayers for those hypothetical arm’s-length parties.
There is also no longer a ‘tax benefit’ purpose test that must be met to recharacterise a transaction or series, but the Explanatory Notes indicate that a transaction or series should be recharacterised “only in exceptional circumstances”.
Other key changes
New subsection 247(2.01) expands the scope of what is subject to a transfer pricing adjustment by setting forth that a transaction or series is deemed to include actual conditions different from the arm’s-length condition if a condition does not exist in respect of the transaction or series but would have existed had the participants been dealing at arm’s length in comparable circumstances.
Finally, new subsection 247(2.03) specifies that any adjustments to amounts for the purposes of the Act would be required to be determined by reference to the OECD Guidelines, as adopted by the Committee on Fiscal Affairs on January 7 2022, but provides that Canada could prescribe its own guidelines or updated OECD Guidelines.
Primary adjustment
If the transfer pricing rules are applicable, then the CRA may adjust the terms and conditions or recharacterise the transaction to reflect an arm’s-length transaction or series in the circumstances. This could result in an increase in the price of goods or services purchased or sold, thereby leading to an increase in taxable income.
Secondary adjustment
Another adjustment the CRA may make under the transfer pricing rules is to deem the taxpayer resident in Canada to have paid a dividend to each non-resident party to the non-arm’s-length transaction. The deemed dividend would be subject to withholding tax under Part XIII of the Act.
Transfer pricing penalties
Significant penalties may apply if a transfer pricing adjustment reduces a taxpayer’s income or capital by an amount exceeding the lesser of 10% of the taxpayer’s gross revenue or C$10 million. A transfer pricing penalty may be imposed unless the taxpayer can demonstrate that reasonable efforts were made to determine and use arm’s-length transfer prices and allocations in respect of the transaction.
The determination of reasonable efforts rests on proper documentation of the transaction. A taxpayer who fails to satisfy the contemporaneous documentation requirements is deemed not to have made reasonable efforts and will be subject to a transfer pricing penalty.
Contemporaneous documentation
Subsection 247(4) of the Act requires a taxpayer to make or obtain contemporaneous documentation, including the details that must be included and the time within which it must be provided to the minister of finance and national revenue (the Minister).
The required content generally reflects the economically relevant characteristics to be considered in applying the arm’s-length principle. The time within which contemporaneous documentation must be provided to the Minister upon written request is now 30 days (a reduction from three months). New subsection 247(4.1) would simplify the documentation requirements where a taxpayer meets certain conditions.
Best practices in developing a transfer price
Intercompany agreements
Whether a transfer pricing adjustment is made depends on whether the parties to a non-arm’s-length transaction can demonstrate that the terms, conditions, and nature of their deal are consistent with what arm’s-length parties would have agreed to in similar circumstances. The best way to support this is often through a well-drafted intercompany agreement, as this is where taxpayers have the most control over the transfer pricing process.
Given the complexity and risks involved, especially with the focus on economically relevant characteristics, it is wise to seek legal advice early. Properly drafted agreements should clearly reflect the characteristics considered by the parties to the transaction and to demonstrate reasonable efforts in determining arm’s-length transfer prices and allocations.
A few best practices in structuring these intercompany service agreements include the following:
Less is not more – agreements should detail the property or services and assets involved, the scope and purpose of the transactions, relations with members of the corporate group, any risks or liabilities assumed, and economic circumstances and contributions of the parties.
Schedule in flexibility – itemise each property or service in a schedule to the agreement to allow for easier amendments. Schedules should also outline pricing methods, service rates, and the considerations used to determine arm’s-length prices.
Stay up to date – regularly update the agreement and its schedules to ensure they reflect the actual transactions and demonstrate any transfer pricing considerations and methods used.
Standardise processes – for groups with frequent intra-group transactions, use template agreements and standardised accounting processes. Consider having each party to the transactions create a resolution to identify the property or services received and the provider of such property or services.
A key takeaway is that agreements, documentation, and internal practices should provide the CRA with a clear, complete picture of the transactions and how they were conducted.
Corporate restructuring
Canada’s domestic transfer pricing rules may apply to the restructuring of an MNE with a Canadian nexus, particularly where the restructuring appears to have a significant tax motivation (e.g., a restructuring that shifts the profits of an MNE to a low-tax jurisdiction).
Section 247 of the Act sets out a general framework to determine pricing for transfers between related parties within an MNE group. If a corporate restructuring has been undertaken involving a Canadian taxpayer and a non-resident non-arm’s-length party, it must accord with the arm’s-length principle.
Chapter IX of the OECD Guidelines states that a transfer pricing analysis of a corporate restructuring generally requires an accurate delineation of the relevant transactions referencing the functions, assets, and risks of the MNE both prior and subsequent to the consummation of the restructuring. As a result, any such restructuring will require an analysis into:
Whether there has been a transfer of functions, assets, and risks within the MNE group; and
Whether arm’s-length consideration has been paid in respect of such transfers.
The following are key considerations concerning best practices related to transfers in the context of a corporate reorganisation or restructuring:
Pricing – ensure that any corporate reorganisation or restructuring is priced in a manner that will compensate the parties to the transaction on arm’s-length terms.
Commercial justification – articulate a commercial purpose for the restructuring to establish that the transaction was not purely motivated by a tax-driven rationale and would have been entered into by arm’s-length parties.
Documentation is critical – obtain independent valuations to support the value of Canadian subsidiaries, transferred assets, and assets whose value may be difficult to ascertain (e.g., intangibles) where the restructuring of the MNE group has a Canadian component. For instance, where a Canadian subsidiary of an MNE group is closed as a result of the restructuring of the MNE group, ensure that any payment for the closure accurately reflects the value of the Canadian subsidiary.
Intangibles
Transfer pricing issues may also arise on cross-border transfers of certain intangibles between related parties. The Act does not contain specific rules dealing with intangibles; however, taxing authorities are generally concerned that the arm’s-length principle’s perceived emphasis on contractual allocations of functions, assets, and risks is susceptible to manipulation with respect to the transfer of intangibles by MNEs.
Although a tax-motivated transfer of assets to allocate profits derived thereon to lower-tax jurisdictions is not inherently offensive under the Act, taxpayers should adopt the following best practices in respect of the transfer of intangibles:
Functional analysis – undertake a functional analysis involving the use or transfer of intangibles, which is grounded in an understanding of the MNE’s business and how the intangibles add value across its supply chain. The analysis should identify the functions performed and risks assumed in respect of the development, maintenance, protection, and exploitation (DEMPE) of the relevant intangibles. This functional analysis should support that the transfer of intangibles accords with the arm’s-length principle.
Exploitation of intangibles – the legal ownership of intangibles will not suffice to establish the entitlement of any profit derived from the exploitation of intangibles. Accordingly, it is important to interrogate the functions performed by related parties within the MNE group to determine whether such relationships conform to the arm’s-length principle.
Commercial justification – articulate a commercial purpose for the transfer of the intangibles to establish that the transaction was not motivated solely for tax purposes.
Entitlement to reimbursements – related parties in an MNE group that add value in connection with the DEMPE of an intangible may be entitled to remuneration for such services. Furthermore, related parties in an MNE group that provide funding and assume financial risk (but do not perform any function in connection with the intangibles) may only be entitled to a risk-adjusted return.
Transfer pricing methodology
Although taxpayers must comply with the arm’s-length principle under Section 247, the Act does not specify how to adhere to that standard. Subsection 247(2.04) of the Act provides that whether a transaction or series includes actual conditions that differ from arm’s-length conditions is to be determined through an analysis where the most appropriate method is selected and applied in accordance with the OECD Guidelines. However, the legislation does not state what those methods are or their hierarchy.
The CRA’s administrative guidance identifies five transfer pricing methodologies (endorsed by the OECD) that are intended to give effect to the arm’s-length principle:
The comparable uncontrollable price (CUP) method;
The cost-plus method;
The resale price method;
The transactional net margin method; and
The transactional profit split (TPS) method.
Although the CRA has not adopted a strict hierarchy among the methodologies, it has accepted that a ‘natural hierarchy’ exists. For instance, the CRA has opined that traditional transaction methods, such as the CUP method, are preferable to the TPS method due to the availability and reliability of data gathered.
Transfer pricing disputes often arise due to disagreement as to which transfer pricing methodology is most appropriate to a taxpayer’s circumstances. As a result, it is critical that taxpayers select a transfer pricing methodology appropriate to their circumstances and document the reasons for that selection.
Contemporaneous documentation
The CRA’s suggested best practices are that contemporaneous documentation should generally include the following:
A description of the taxpayer’s relevant business and its general organisation;
The selection of a particular transfer pricing methodology, including an explanation as to why that methodology is more appropriate than other methods;
Where the subject transaction involves the transfer of intangible assets, taxpayers should prepare a projection of the expected benefits conferred in respect of acquiring the assets;
The scope of search and criteria used to identify comparable transactions;
An analysis of the factors considered when assessing the comparability of benchmark transactions; and
The assumptions, strategies, and policies of the parties as they relate to tangible assets, intangible assets, and the services being transferred.
Taxpayers must prepare this documentation on or before the taxpayer’s documentation ‘due date’ (which is generally the date on which the taxpayer’s tax return is due for the relevant year) or the fiscal period in which the transaction was entered into.
In practice, the CRA will generally commence a transfer pricing audit with a request for contemporaneous documentation and will usually not entertain any request for an extension by the taxpayer. Accordingly, it is imperative that contemporaneous documentation is readily available in advance of a contemplated audit.
