Article written by Avinash S. Tukrel at Segal GCSE, in the quarterly Canadian news roundup, a newsletter published by Canadian member firms of Moore North America. This article on transfer pricing rules is part of our mission to become your partner in success by keeping you up to date with the latest developments.
The Department of Finance Canada, on June 6, 2023, released the much-awaited transfer pricing public consultation paper Consultation on Reforming and Modernizing Canada’s Transfer Pricing Rules. The Federal Budget 2021 previously announced the Government’s intention to consult on Canada’s transfer pricing rules to protect the tax system’s integrity while preserving Canada’s attractiveness as a destination for new investment and business activity. The consultation paper includes proposed draft revisions to Section 247 of the Canada Income Tax Act (“the Act”) and potential changes to administrative measures.
Why these changes?
The catalyst for these changes and consultation is the view that Canada’s existing transfer pricing legislation does not provide clear guidance on applying the arm’s length principle, and the rules have not been revised since their introduction in 1997. In comparison, other countries have updated their transfer pricing rules to align with international tax reform and related developments with detailed guidance and provisions.
A broad consensus exists that the limited guidance on Canada’s application of the arm’s length principle was evidenced in the Federal Court of Appeal’s decision in The Queen v. Cameco Corporation, 2020, FCA 112.
Clarification of the application of the arm’s length principle in Canada
The fundamental change pertains to possible amendments to the transfer pricing adjustment provisions in Section 247 of the Act to clarify the application of the arm’s length principle in Canada and align local legislation with international consensus and best practices. Appendix A of the consultation paper includes proposed draft legislative measures such as:
- To provide a new definition for economically relevant characteristics in line with the Organisation for Economic Cooperation and Development (“OECD”) 2022 Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (“OECD 2022 TP Guidelines”).
- The objective of this proposed rule is to delineate the conduct (i.e., substance) of the parties to a transaction and not limit conclusions to just the contractual terms (i.e., form), therefore, placing a significant emphasis on the function, asset, and risk (FAR) analysis of the related parties in the context of a related party transaction or series of transactions.
- The Canada Revenue Agency (“CRA”) will be able to disregard the transaction(s) in exceptional circumstances.
- Define comparable circumstances to reduce hypothetical comparisons for delineated transactions compared to what independent third parties dealing at arm’s length would have agreed to.
- Requirement that controlled transactions or a series of transactions will be compared to those of independent third parties in comparable circumstances. It is vital to note that the proposed conditions will be interpreted broadly and rely on any relevant financial and commercial information in the transaction(s) context.
- Application of the arm’s length principle will require assessing the conditions that would have been included in comparable transactions entered into by third parties in the context of the delineated controlled transaction(s) in comparable circumstances.
- Where such information is unavailable, the CRA will be able to assess whether the controlled transaction(s) was conducted on an arm’s length basis using a hypothetical basis.
- Include legislative provisions to align Canada’s Transfer Pricing legislative framework with the OECD 2022 TP Guidelines. The proposed changes also indicate that any future changes to the OECD 2022 TP Guidelines will not automatically change the interpretation of the transfer pricing rules in Canada,. which provides certainty to taxpayers, but potentially create an inconsistency with evolving guidance on international tax reform and consensus.
Administrative measures
Additionally, the consultation process invites key stakeholders to provide input on transfer pricing administrative measures such as documentation, penalty provisions, and adopting a simplified approach to specific business circumstances and transactions. The proposed administrative measures include, but are not limited to:
- Changes to compliance requirements through annual reporting schedules, potentially relieving the existing compliance burden for certain taxpayers. Introduction of minimum thresholds and exemptions for certain taxpayers based on size and types of transactions.
- Adoption of the OECD BEPS Action 13 Master File and Local File approach for transfer pricing documentation for Canadian taxpayers.
- Changes to transfer pricing penalty thresholds to encourage taxpayers to maintain contemporaneous transfer pricing documentation and reduce non-compliance.
- Provisions relating to the protection plan or full returns
Safe harbour provisions or acceptable arm’s length returns for:- Interest rates
- Low value-added intra-group services
- Routine distribution functions
The firm will continue to review the consultation paper and monitor related developments in the coming months to provide inputs on what is likely to be a key milestone in Canada’s transfer pricing legislative reform at a crucial time for taxpayers in an ever-evolving complex international tax landscape.
This consultation process allows key stakeholders to actively participate and shape a transfer pricing framework that is robust and sustainable for the future. Comments and responses are invited to 23 questions from various stakeholders by July 28, 2023.
For more information and to provide your perspective as a business on the impact of the proposed changes, please get in touch with our experts.
