Canada: An Overview Of Transfer Pricing In Canada


In Canada v. GlaxoSmithKline Inc. ("GlaxoSmithKline"), Justice Rothstein of the Supreme Court of Canada succinctly summarized transfer pricing and the tax concerns surrounding it.

Transfer pricing issues arise when entities of multinational corporations resident in different jurisdictions transfer property or provide services to one another.  These entities do not deal at arm's length and, thus, transactions between these entities may not be subject to ordinary market forces.  Their absence may result in prices being set so as to divert profits from the appropriate tax jurisdiction.  Since 1939, the Income Tax Act has included provisions under which a Canadian taxpayer may be reassessed to include, in Canadian profits, the difference between the prices for property paid to a non-resident with which it does not deal at arm's length and what those prices would have been had they been dealing at arm's length.

Aggressive transfer pricing practices erode the Canadian tax base, reducing government revenues.  Unsurprisingly, the Canadian government has, therefore, enacted income tax provisions to prevent such practices.  This article provides an overview of those provisions, which are primarily found in section 247 of the Income Tax Act.

Transfer Pricing Adjustment

The transactions potentially subject to being adjusted under the transfer pricing provisions are those between a taxpayer and a non-resident person with whom the taxpayer does not deal at arm's length.  A taxpayer is basically any person within Canada's jurisdiction to tax, regardless of whether the person is a resident or non-resident.  Non-arm's length transactions involving partnerships can also potentially be adjusted.  The non-arm's length transactions described above can be subject to two types of adjustment.

The first type of adjustment applies if the terms or conditions of a transaction differ from those that would have been made between person's dealing at arm's length.  Where that is the case, there is an adjustment of any amounts that would be determined for income tax purposes in respect of the taxpayer to the amounts that would have been determined if the terms and conditions had been those that would have been made between persons dealing at arm's length.

The second type of adjustment applies if a transaction would not have been entered into between persons dealing at arm's length and can reasonably be considered not to have been entered into primarily for bona fide purposes other than to obtain a tax benefit.  Where that is the case, there is an adjustment of any amounts that would be determined for income tax purposes in respect of the taxpayer to the amounts that would have been determined if the transaction entered into between the participants had been the transaction that would have been entered into between persons dealing at arm's length, under terms and conditions that would have been made between persons dealing at arm's length.  In Information Circular 87-2R:  International Transfer Pricing ("IC87-2R"), the CRA has stated that it will only use this power of recharacterization in limited circumstances.

The above provisions are geared toward stopping aggressive transfer pricing by making "Upward Adjustments".  Upward adjustments are adjustments that increase a taxpayer's income, reduce its losses or reduce its capital expenditures.  These types of adjustments generally increase the amount of Canadian tax owed.

"Downward Adjustments" are adjustments that decrease a taxpayer's income, increase its losses or increase its capital expenditures.  These type of adjustments can reduce Canadian tax owed.  Downward Adjustments are not automatically made.  The Minister of National Revenue ("Minister") does, however, have the power to make such Downward Adjustments if, in her opinion, the circumstances are such that it would be appropriate that the adjustment be made.

Transfer Pricing Penalty

A transfer pricing penalty may apply in addition to any increase in taxes from Upward Adjustments.  The penalty applies where the net amount as calculated below exceeds the lesser of $5,000,000 and 10% of the taxpayer's gross revenue for the tax year.  The relevant calculation is as follows.

  • the total amount of Upward Adjustments,


  • the total amount of Upward Adjustments for which the taxpayer made reasonable efforts to determine an accurate transfer price or allocation, and
  • the total amount of Downward Adjustments for which the taxpayer made reasonable efforts to determine an accurate transfer price or allocation.

When the penalty is applicable, the amount of the penalty is 10% of the net amount as calculated above.

Notice that the penalty may not apply even when there has been Upward Adjustments.  This is because reasonable efforts to determine the transfer price or allocation are taken into account in the calculation to determine whether the penalty applies and its amount.  In effect, reasonable efforts to determine an accurate transfer price or allocation can negate the application of the penalty.

Reasonable Efforts and Contemporaneous Documentation

In general, the determination of whether a taxpayer has made reasonable efforts is a question of fact.  However, a taxpayer is deemed not to have made reasonable efforts if the taxpayer does not obtain contemporaneous documentation in respect of the transaction and also satisfies the following.  The documentation must be obtained on or before the taxpayer's documentation-due date, which is generally the taxpayer's tax return filing due date.  If the transaction spans multiple years, material changes must also be documented by the documentation-due date of the year of the material change.  The documentation must also be provided to the CRA within three months of a written request.

Contemporaneous documentation consists of records and documents that provide a complete and accurate description of the following:

  • the property or services to which the transaction relates,
  • the terms and conditions of the transaction and their relationship, if any, to the terms and conditions of each other transaction entered into between the participants in the transaction,
  • the identity of the participants in the transaction and their relationship to each other at the time the transaction was entered into,
  • the functions performed, the property used or contributed and the risks assumed, in respect of the transaction, by the participants in the transaction,
  • the data and methods considered and the analysis performed to determine the transfer prices or the allocations of profits or losses or contributions to costs, as the case may be, in respect of the transaction, and
  • the assumptions, strategies and policies, if any, that influenced the determination of the transfer prices or the allocations of profits or losses or contributions to costs, as the case may be, in respect of the transaction.

The recent Tax Court of Canada case of McKesson Canada Corporation v. The Queen ("McKesson") may encourage the CRA to dismiss contemporaneous documentation as inadequate.  That could lead to a transfer pricing penalty applying as discussed above.  In McKesson, it was clear that the study used to justify the transfer price (a discount) was not relied upon by the taxpayer and was simply an after the fact justification.  Nonetheless, the CRA accepted the taxpayer's contemporaneous documentation and did not apply a transfer pricing penalty, which led Justice Boyle to state the following:

Given that the TDSI Reports were the only contemporaneous documentation, and given my observations, comments and conclusions on those opinions and the role of TDSI, it appears to me that CRA may need to review its threshold criteria with respect to subsection 247(4).  I would not have expected last minute, rushed, not fully informed, paid advocacy that was not made available to the Canadian taxpayer and not read by its parent, could easily satisfy the contemporaneous documentation requirement.

Residents of Canada and non-residents carrying on business in Canada are required to file T106 documentation (a Summary and Slips) if such persons undertake certain transactions relating to a business carried on in Canada.  The transactions must be with non-arm's length non-residents and be for amounts in excess of $1,000,000.  The T106 requirement relates to contemporaneous documentation because the T106 Slip asks whether such documentation for the tax year has been prepared or obtained.  A false statement or omission on T106 documentation is punishable with a penalty of $24,000, and there are also late filing penalties.

Withholding Tax

In simplified terms, a corporation resident in Canada that is subject to Upward Adjustments under the transfer pricing rules may be deemed to pay a dividend to the non-resident with which the corporation was transacting.  The amount of the dividend is equal to the Upward Adjustments associated with the transactions with the particular non-resident minus any Downward Adjustments also associated with such transactions.  The CRA provides the following example in IC87-2R:  "if a taxpayer purchased property from its foreign parent at a price in excess of what arm's length parties would have paid, the price would be reduced ... .  The excess amounts paid to the parent ... are deemed to be a dividend to the foreign parent."

The deemed dividend is subject to 25% withholding tax.  The amount of withholding tax may be reduced under one of the bilateral tax treaties Canada has entered into.  The Minister is also granted the discretion to reduce the amount of the deemed dividend and any interest on it if the non-resident pays to the corporation resident in Canada an amount agreed to by the Minister.

Determining the Transfer Price

The focus of the transfer pricing provisions is the determination of an arm's length transfer price or allocation.  Yet, the Income Tax Act is silent on how to go about doing that.  The CRA has relied on the methods set out in the Organization for Economic Co-operation and Development, Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations ("OECD Guidelines").  The methods set out in the OECD Guidelines generally involve finding comparable arm's length transactions and using those transactions to determine the correct transfer price or allocation.  The OECD Guidelines set out the following methods which have been endorsed by the CRA:

  • Comparable uncontrolled price ("CUP") method;
  • Resale price method;
  • Cost plus method;
  • Profit split method; and
  • Transactional net margin method.

In IC87-2R, the CRA states that the methods form a hierarchy with the CUP method being more reliable than the resale price method and cost plus method, and those three methods being more reliable than the bottom two.  Nonetheless, the CRA concedes in IC87-2R that "[t]he most appropriate method in a given set of circumstances will be the one that provides the highest degree of comparability between transactions."  Courts have placed less emphasis on the OECD Guidelines.

The exact position of the courts on transfer pricing has been somewhat uncertain because the leading case, GlaxoSmithKline, involved an older version of the transfer pricing rules.  However, in McKesson, Justice Boyle found that the principles set out in GlaxoSmithKlien apply to the current transfer pricing provisions.  Justice Boyle summarized those principles as follows:

(1) A judge is to take into account all transactions, characteristics and circumstances that are relevant (including economically relevant) in determining whether the terms and conditions of the transactions or series in question differ from the terms and conditions to which arm's length parties would have agreed.

(2) The transfer pricing provisions of the Act govern and are determinative, not any particular methodology or commentary from the OECD Guidelines, or any source other than the Act.

I would add the observation that OECD Commentaries and Guidelines are written not only by persons who are not legislators, but in fact are the tax collection authorities of the world. Their thoughts should be considered accordingly. For tax administrators, it may make sense to identify transactions to be detected for further audit by the use of economists and their models, formulae and algorithms. But none of that is ultimately determinative in an appeal to the Courts. The legal provisions of the Act govern and they do not mandate any such tests or approaches. The issue is to be determined through a fact finding and evaluation mission by the Court, as it is in any factually based issue on appeal, having regard to all of the evidence relating to the relevant facts and circumstances.

(3) Arm's length prices are established having regards to the independent interests of each party to the transaction. In this appeal, this means that the RSA transactions must be looked at from both the perspectives of McKesson Canada and of MIH.

(4) Other arm's length transactions can be relied upon as comparables in a transfer pricing analysis only if either there are no material differences that would affect pricing, or if reasonably accurate adjustments can be made to eliminate the effects of such differences.

(5) Quoting from GlaxoSmithKline:

61 As long as a transfer price is within what the court determines is a reasonable range, the requirements of the section should be satisfied. If it is not, the court might select the point within a range it considers reasonable in the circumstances based on an average, median, mode, or other appropriate statistical measure, having regards to the evidence that the court found to be relevant. I repeat for emphasis that it is highly unlikely that any comparisons will yield identical circumstances and the Tax Court judge will be required to exercise his best informed judgment in establishing a satisfactory arm's length price.


Taxpayers, especially multinational corporations, are motivated to use transfer pricing to shift profits to low tax jurisdictions in order to reduce the amount of tax they pay.  At the same time, governments in the developed world are becoming increasingly concerned about the tax base erosion caused by profit shifting.  This means that transfer pricing will be the subject of legislative change and litigation for years to come.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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