June 29, 2023
Canada's Department of Finance releases transfer pricing rules consultation paper
On 6 June 2023, the Department of Finance released "Consultation on Reforming and Modernizing Canada's Transfer Pricing Rules" (the consultation paper), which follows through on the commitment made in the 2021 federal budget to review these rules. The consultation paper includes draft revisions to section 247 of the Income Tax Act (the Act), as well as potential administrative measures. Interested stakeholders are invited to provide comments by 28 July 2023.
This Tax Alert provides a summary of the key points of the consultation paper.
Following the Crown's loss in the Cameco case at both the Tax Court of Canada and Federal Court of Appeal,1 the government committed to a review of the transfer pricing rules in Canada. The consultation paper represents the Department of Finance's opening foray into potential legislative amendments and revised administrative measures applicable to transfer pricing in Canada. It also raises certain streamlined pricing approaches as topics for further discussion.
The consultation paper sets out a series of 23 questions regarding specific elements of the proposals. Draft legislative amendments to implement certain proposed measures are included in Appendix A of the consultation paper.
The main legislative proposal concerns possible amendments to the transfer pricing adjustment rules in section 247 of the Act. These potential changes are intended to provide greater clarity on the application of the arm's-length principle in Canada, in part by attempting to better align the language in the provision with that published in the Organisation for Economic Co-operation and Development (OECD) Transfer Pricing Guidelines.2
New definitions are proposed. In particular, the new term "economically relevant characteristics" is intended to delineate all of the information ("conditions," with its own interpretive rule) that should be taken into account when setting and analyzing prices in intercompany transactions, with an emphasis on the functions and actual conduct of the parties, to determine the "delineated transaction." This is a much broader undertaking than the existing transfer pricing legislation currently imposes.
Thereafter, as a first element, for purposes of making a transfer pricing adjustment, a comparison is required between the conditions of the delineated transaction and the conditions that would have been included had the parties been dealing at arm's length in comparable circumstances. Where the conditions from this comparison differ, the taxpayer's reported income or expense amount (referred to as the "initial amount") may be adjusted to the quantum or nature that would have been determined if arm's-length conditions had applied.
The second element of the proposed legislative changes introduces new "nonrecognition and replacement" provisions to replace the current "recharacterization" provisions in paragraphs 247(b) and (d) of the Act. Nonrecognition will apply where, taking into consideration the participants' perspectives and the options realistically available to them at the time of entering into the transaction, it is determined that both:
Where the Canada Revenue Agency (CRA) determines the nonrecognition-and-replacement rule applies, "the delineated transaction or series is to be disregarded and replaced with an alternative transaction or series that comports as closely as possible with the facts of the delineated transaction or series while achieving an expected result that, had the participants been dealing at arm's length in comparable circumstances, would have been commercially rational."3
This nonrecognition-and-replacement feature appears to be largely directed at addressing difficulties the Crown experienced in supporting its recharacterization position in the Cameco case. The consultation paper makes several references to the Cameco case to explain the Department of Finance's tax policy concerns with respect to the current rules and to illustrate how the proposed nonrecognition-and-replacement rule could have operated in similar circumstances.
Third, the consultation paper proposes to insert a consistency provision, indicating that the Canadian transfer pricing rules are to be applied in a manner so as to achieve consistency with the OECD Transfer Pricing Guidelines.4 An embedded caveat of "unless the context otherwise requires" provides the CRA with leeway in interpretation. Whether the application of the OECD Transfer Pricing Guidelines is to be made using a static or an ambulatory approach to future guidance changes is left open for stakeholder input and later determination.
The consultation paper invites stakeholders to provide input on administrative matters connected to transfer pricing, such as documentation and penalty provisions and the possibility of adopting more-modern or simplified approaches in specific situations.
The consultation paper notes that these measures are intended to reduce transfer pricing disputes, ease compliance burdens and allow the CRA to focus its resources on transactions that pose a higher risk of base erosion.
Administrative measures considered in the consultation paper include the following potentially significant developments:
Streamlined pricing approaches
The consultation paper raises certain streamlined pricing approaches for consideration and stakeholder input without indicating the government's clear directional intent to adopt these approaches.
Stakeholder comments are invited through 28 July 2023. Commentators are asked to advise whether they consent to disclosure of their submission in whole or in part.
EY Canada will review the consultation paper in detail and will provide comments to the Department of Finance.
The substantive elements of Canada's transfer pricing rules have not been revised since their original introduction in 1997. The Department of Finance's consultation paper provides an opportunity for stakeholders to provide input on this important component of Canadian tax law.
While the intention of the Department of Finance is to reduce uncertainty in the interpretation of the transfer pricing rules in Canada, the proposed legislative revisions could create additional avenues of uncertainty and broaden the current landscape for Canadian transfer pricing disputes. In particular, the focus on "economically relevant characteristics" — an inherently subjective concept — could lead to more frequent and broader disputes. This could, in turn, increase the need for more effective dispute resolution mechanisms, a topic that is not addressed in the consultation paper.
The timing and potential application date of revised legislative proposals resulting from the consultation process are uncertain. Nonetheless, given the recurring nature of transfer pricing, taxpayers should review their current transactions and documentation in light of the directional intentions indicated by the government's proposals and consider whether proactive changes and/or improvements are warranted.
Furthermore, the administrative measures discussed in the consultation paper, which are intended to reduce compliance and administrative burdens, are worthy of serious consideration as part of the overall reframing of the Canadian transfer pricing environment. However, it is not clear that the measures under consideration as currently framed are wholly consistent with the legislative proposals and will achieve the stated objectives.
To view the full Department of Finance consultation paper, visit: Consultation on Reforming and Modernizing Canada's Transfer Pricing Rules - Canada.ca.
For more information, please contact your EY or EY Law advisor or one of the following professionals:
Ernst & Young LLP (Canada), Toronto
Ernst & Young LLP (Canada), Ottawa
Ernst & Young LLP (Canada), Quebec and Atlantic Canada
Ernst & Young LLP (Canada), British Columbia
Ernst & Young LLP (Canada), Praries
Published by NTD’s Tax Technical Knowledge Services group; Carolyn Wright, legal editor
1Cameco Corporation v. The Queen, 2018 TCC 195; aff'd 2020 FCA 112. Also, see EY Tax Alert 2020 Issue No. 40, Federal Court of Appeal rejects Crown appeal in Cameco transfer pricing case.
2 OECD Transfer Pricing Guidelines refers to the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations.
3 Proposed paragraph 247(1.3)(b) of the Act.
4 As provided for in proposed subsection 247(2.03).