Transfer pricing has been part of Canadian tax legislation since the tax’s inception, and currently, the rules have been in place for 25 years. Canadian transfer pricing regulations align with the Guidelines provided by the Organization for Economic Co-operation and Development (OECD). Currently, they are incorporated within the Income Tax Act.
Arm’s Length Principle
According to Canadian law, the intercompany price must align with the arm’s-length principle, based on statute, administrative practice, and judicial decisions. It requires pricing that a reasonable person would agree to maximize profit in similar circumstances. Transactions should ideally be priced separately for precise arm’s-length pricing, though bundling may be allowed if transactions are closely linked.
Related Party Definition
Under Canadian tax law, parties are considered related if they are closely related by family (through blood, marriage, common law, or adoption). A person is also considered related to a corporation if they control it; the corporation is controlled by a related group to which the person belongs, or the corporation is controlled by a person related either to the person or to the entity. Two corporations are considered related if they are controlled by the same person or related persons, or if there are connections between the people or groups controlling each company. Even if the transactions between related parties seem fair, they are still not treated as being at arm’s length for tax purposes.
Transfer Pricing Methods
The methods that can be used to determine the arm’s length price in Canada are based on the OECD guidelines and include:
- Comparable Uncontrolled Price Method (CUP)
- Resale Price Method (RPM)
- Cost Plus Method (CPM)
- Transactional Net Margin Method (TNMM)
- Profit Split Method (PSM)
Comparability Analysis
In Canada, the comparability analysis in transfer pricing is in line with the guidelines in Chapter III of the OECD Transfer Pricing Guidelines. This means the arm’s length range is used by utilizing statistical data to reach a fair price between related parties. To do this, five significant factors are considered: (1) The unique features of the goods, services, or rights being transferred; (2) The functions performed by the parties including, the assets they use, and risks they assume; (3) The contractual obligations of the parties; (4) The economic environment; and (5) The business objectives of the parties, such as market entry goal or pricing objectives. Only when the factors are adequately aligned can the relevant adjustments and comparisons be made to determine a fair, arm’s length price. To determine comparable transactions, the law states a preference for local comparables, though foreign ones are allowed if they meet the standards of comparability. The law does not allow the tax authority to use secret comparables.
Documentation Requirements
Transfer pricing documentation requirements in Canada consist of the Country-by-Country (CbC) report. Multinational groups with total consolidated revenue of at least €750 million, need to file a CbC report. This is usually done by the ultimate parent entity if it is a Canadian resident. However, a Canadian entity that isn’t the parent must file if the parent’s country doesn’t require CbC reporting, doesn’t have an agreement with Canada to exchange reports, or has a systemic failure to share them—if notified by the CRA. The report must be submitted within 12 months after the end of the group’s fiscal year.
Advance Pricing Agreements (APA) and Mutual Agreement Program (MAP)
An Advance Pricing Arrangement (APA) is an agreement between a taxpayer and the tax authority that sets out how transfer pricing will be done for future cross-border transactions. APAs help avoid disputes and double taxation. Canada has a voluntary APA program that allows companies to agree in advance with the Canada Revenue Agency on how to price related-party transactions, helping to avoid future disputes. The program was officially introduced in 1994 and is now governed by updated guidelines from 2024. For existing tax disputes, Canada offers a Mutual Agreement Procedure (MAP) under its tax treaties.
Mutual Agreement Program (MAP)
Canada’s MAP allows taxpayers to resolve international tax disputes—such as double taxation or transfer pricing issues—under the terms of its tax treaties. Taxpayers can request MAP even if an audit or court case is in progress, and tax collection is typically suspended during the process. The Canada Revenue Agency aims to resolve most cases within 24 months. If the same issue affects more than one year, a multi-year resolution may be available.
Approach to Transfer Pricing Audits
The tax authority has broad powers to examine taxpayer records, requiring cooperation between taxpayers and the tax authority to resolve transfer pricing issues. The audit activity has intensified, supported by additional funding to address tax evasion and avoidance.
Penalties
Taxpayers who make false statements or omissions in tax are subject to monetary penalties of 50% of the understated tax. In the most serious cases of tax evasion, fines could be imposed at a rate between 50% and 200% of the tax evaded, or a maximum of two years in prison. If the taxpayer is prosecuted via indictment, penalties could include fines of up to 200% of the evaded tax but a maximum of five years in prison. Taxpayers can voluntarily disclose stale outstanding tax obligations and the interest calculated thereon, without penalty, if the voluntary disclosure occurs before any audit or investigation by a taxing authority.
Taxation at a Glance
In Canada, both the federal and provincial governments collect income tax from individuals and corporations. Most provinces let the federal government handle tax collection, except Quebec and Alberta. Canada also raises significant revenue from sales taxes like GST and HST. The main tax law is the federal Income Tax Act, supported by regulations and case law, and it also forms the basis for most provincial tax laws. The currency of Canada is the Canadian dollar. The official name of the Canadian tax authority is the Canadian Revenue Agency (CRA).
The table below provides a summary of the main taxation rates related to businesses:
Tax Type | Tax Rate |
Corporate Tax | 38% |
VAT | 5% to 15% |
Withholding tax on dividends to non-residents | 25% |
Withholding tax on interest to non-residents | 25% |
Withholding tax on royalties to non-residents | 25% |
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