Transfer pricing in Canada is governed by:
- The legal framework specified in the Income Tax Act (Act), in particular in its Section 247;
- The administrative rules of the Canada Revenue Agency (CRA) as expressed in its Information Circulars (IC), in particular IC 87-2R (International Transfer Pricing), IC 94-4R (International Transfer Pricing: Advanced Pricing Arrangements (APAs)), and IC 71-17R4 (Request for Competent Authority Consideration Under Mutual Agreement Procedures in Income Tax Conventions); and
- The audit practices of the CRA auditors.
Although Canada is a member of the OECD, the OECD transfer pricing guidelines are not directly implemented into domestic law. However, the CRA endorses the use of the OECD transfer pricing guidelines. The 2016 Federal Budget implemented CbC reporting in Canada in line with Action 13 of the OECD BEPS project (see Sec. 12.4.3.).
The subsections from 247(1) to (11) relating to transfer pricing adjustments are effective for tax years beginning after 1997. In 2012, subsections 247(12) to 247(15) were added for rationalizing the withholding tax implications of transfer pricing adjustments. However, the subsections dealing with penalties are only effective for tax years beginning after 1998. The statute of limitations for readjustments involving transactions with related parties is 7 years, unless one of the exceptions (e.g., instances of fraud, misrepresentation, etc.) applies. Given that Canadian tax treaties usually allow for a shorter period of time for taxpayers to request the initiation of a MAP, there can be instances of TP readjustments that cannot be submitted for review under MAP due to expiry of the deadline.
The CRA's views about transfer pricing are expressed in Information Circular Numbers IC94-4R, IC94-4R, and IC71-17R6 and various transfer pricing memorandums issued from time to time.
Paragraph 251(1)(a) contains a general presumption to the effect that related persons do not deal with each other at arm’s length. Sub-section 251(2) of the Income Tax Act defines related persons to include the following:
- Individuals connected by blood relationship, marriage, common-law partnership, or adoption;
- A corporation is related to another person (including another corporation) if:
- that person controls the corporation, if it is controlled by one person;
- that person is a member of a related group that controls the corporation; or
- that person is related to the persons described above.
- Two corporations are related to each other if:
- the two corporations are controlled by the same person or group of persons;
- each of the corporations is controlled by one person and the person who controls one corporation is related to the person who controls the other corporation;
- one of the corporations is controlled by one person and that person is related to any member of a related group that controls the other corporation;
- one of the corporations is controlled by one person and that person is related to each member of an unrelated group that controls the other corporation;
- any member of a related group that controls one of the corporations is related to each member of an unrelated group that controls the other corporation; or
- each member of an unrelated group that controls one of the corporations is related to at least one member of an unrelated group that controls the other corporation.
Canada’s domestic law does not specify the use of any particular method for related party transactions. However, the Canada Revenue Agency (CRA) published Transfer Pricing Memorandum-14 on 31 October 2012 in which it has endorsed the transfer pricing methods recommended in the OECD transfer pricing guidelines. The acceptable transfer pricing methods in Canada are:
- The comparable uncontrolled price (CUP) method;
- The resale price method (RPM);
- The cost-plus method (CPM);
- The transactional profit split method (TPSM); and
- The transactional net margin method (TNMM);
Canada follows the OECD transfer pricing guidelines regarding the use of the most appropriate method that replaces the natural hierarchy of methods. The CRA endorses that the focus of determining the method to use should be the method that provides the most direct view of arm's length pricing. Generally, the traditional transaction methods like CUP are preferred over transactional profit methods (TPSM and TNMM). But for CRA, these changes do not completely substitute the natural hierarchy but there is more focus on the relevancy of the degree of comparability available under each of the methods and the availability and reliability of the data.
A fresh benchmarking study is not required to be done every year if the facts and circumstances have not materially changed for the transaction from those that apply in the year of the study. The use of comparables depends on the facts and circumstances of the transaction. Generally, the CRA prefers the use of local comparables if a Canadian taxpayer is the tested party, but accepts the use of foreign comparables if the comparability standards are met. Canada’s domestic law instructs taxpayers not to use interquartile ranges or multiple-year averages to determine arm’s length prices. Further, as per Transfer Pricing Memorandum-04 published by the CRA on 27 October 2003, the tax authorities have the right to collect secret comparables as an audit tool for screening purposes and for secondary support ("sanity checks"). However, secret comparables are used as a basis of assessment only as a last resort.