Budget 2025: A "Modernization" Of Canada's Transfer Pricing Regime

In Budget 2025, the Government proposes significant amendments to Canada's transfer pricing framework, with the stated objectives of "modernizing" the rules and enhancing their alignment with OECD norms, including the application of the "arm's length principle". (By way of background, the proposed amendments largely build off of the consultation paper released by the Department of Finance in June 2023, which followed commentary contained in Budget 2021 suggesting the need for transfer pricing reform). For large Canadian companies and multinational enterprises with Canadian operations, the proposed changes can be expected to have important implications for pricing policies, intercompany documentation, and audit preparation timelines. Budget 2025 estimates that the transfer pricing and other international tax measures announced in the Budget will generate more than CAD $500 million in additional revenue for the Government over the five years following their enactment.

Canadian Transfer Pricing Rules: An Overview

Canada's transfer pricing rules are designed to ensure that cross-border transactions between non-arm's length entities, including members of a multinational enterprise ("MNE"), reflect pricing arrangements that would have been agreed to between parties dealing at "arm's length". The overarching objective is to protect the integrity of the Canadian tax base by preventing the inappropriate allocation of income or deductions between related entities in different jurisdictions.

Section 247 of the Income Tax Act (Canada) (the "Tax Act") empowers the Canada Revenue Agency (the "CRA") to adjust the terms and pricing of a transaction if they do not reflect an arm's length outcome. In addition, Canadian taxpayers are required to maintain "contemporaneous documentation" supporting their transfer pricing methodologies, functional and risk analyses, and choice of comparables. Where documentation is incomplete or is not maintained, penalties may be imposed.

The Canadian transfer pricing rules operate within the broader framework of the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (the "OECD Guidelines"). Canada's recognition of, and general adherence to, these guidelines is intended to ensure an alignment and level of consistency with global standards, while, at the same time, preserving domestic enforcement flexibility. According to Budget 2025, the proposed transfer pricing amendments are aimed at strengthening this alignment and improving administrative efficiency.

Overview of Key Proposed Amendments

Budget 2025 proposes to update or "modernize" Canada's transfer pricing regime, with particular emphasis on clarifying analytical standards, elevating the role of economic substance, and tightening compliance timelines. The new provisions (if enacted) would apply to taxation years beginning on or after November 4, 2025.

Significant components of the proposed changes include the following:

• Introduction of a new analytical rule – The new legislation will define and codify the concept of "arm's length conditions," requiring that intercompany transactions be evaluated not only based on contractual terms but also on the "economic reality" or "actual conditions" of the arrangement, with greater attention directed toward the actual conduct of the parties and consistency with the OECD's emphasis on substance over form. In particular, the proposed transfer pricing adjustment provision contained in Budget 2025 would operate to adjust the quantum and nature of amounts relating to a taxpayer's transactions with a non-arm's length non-resident if they include "actual conditions different from arm's length conditions." For this purpose, "arm's length conditions" mean the conditions that would have applied had the parties been dealing at arm's length in comparable circumstances, including the possibility that the parties would not have entered into the transaction or series at all, or would have entered into a different one, had they been dealing at arm's length.¹
• Recognition of "economically relevant characteristics" – The determination of transfer prices would, under the proposed changes, explicitly consider a set of relevant factors, including contractual obligations, functions performed, assets used, risks assumed, market conditions, and business strategy. These criteria collectively serve to reinforce the objective of creating an all-inclusive approach to comparability and profit allocation.
• Interpretations consistent with the OECD Guidelines – The proposed new measures contain a rule requiring that analysis and determinations under section 247 of the Tax Act to be conducted in a manner consistent with the OECD Guidelines (as they existed in 2022, unless prescribed otherwise by regulation).
• Revised documentation and administrative rules – Budget 2025 proposes updated documentation requirements intended to align with the revised analytical framework to be followed when applying the arm's length principle. In addition, the absolute dollar penalty threshold for transfer pricing penalties will increase from CAD $5 million to CAD $10 million, potentially offering limited relief to smaller taxpayer groups with more modest sized transactions. Finally, and perhaps most significantly, the timeframe for providing documentation upon CRA request will be reduced from the current three month period to only 30 days, suggesting an enhanced need for timely recordkeeping and internal coordination.
• Simplified documentation regime – The Government has indicated that certain taxpayers may qualify for a streamlined compliance documentation process in circumstances where prescribed conditions are met, potentially reducing the administrative burden associated with lower-risk or smaller-sized transactions.²

Collectively, these and the other transfer pricing related measures in Budget 2025 represent a meaningful shift toward a more principle-based and administratively streamlined transfer pricing framework, and also reflect the Government's intention to align Canadian practice more closely with global developments under the OECD, including its Base Erosion and Profit Shifting initiatives.

Implications for Taxpayers

The transfer pricing changes proposed in Budget 2025 may have both practical and strategic implications for organizations with cross-border related-party transactions. Taxpayers will need to assess the extent to which their existing transfer pricing policies, functional analyses, and supporting documentation are consistent with the new measures (assuming they are enacted).

Critical considerations and takeaways include the following:

• The need for multinational enterprises ("MNEs") to evaluate whether the contractual terms in their various intragroup transactions align with the actual behaviours of the relevant parties (given the proposed new emphasis on the substance of a relationship over its contractual form).
• The new 30-day documentation response deadline will require MNEs to ensure documentation is maintained on a more contemporaneous and readily accessible basis, giving rise to the need for greater coordination between the operational functions of the business on the one hand, and the tax and finance functions on the other.
• Transfer pricing studies should be refreshed to confirm that comparables and profit level indicators remain appropriate. Benchmarking should be evaluated to ensure it properly incorporates the newly defined "economically relevant characteristics".
• An increased focus by the CRA on real-time documentation requirements (as supported by the new measures) could suggest an increased frequency of penalty assessments for non-compliant taxpayers.
• Given the scope of the changes, many taxpayers will likely benefit from proactively seeking to identify potential new risk areas, along with opportunities to streamline documentation and compliance procedures.

Conclusion

While the arm's length principle underlying the Canadian transfer pricing regime remains firmly entrenched, the measures contained in Budget 2025, if enacted, may meaningfully impact the surrounding analytical framework and compliance practices, all with a view to bring the Canadian rules more in line with contemporary OECD standards. It is strongly recommended that taxpayers take this opportunity to reassess their intercompany pricing structures, documentation practices, and audit readiness.

Footnotes

1 "Conditions" are defined broadly under the proposed new rules and would include any commercial or financial information relevant to the transaction (or series). In addition, a transaction (or series) would be deemed to have actual conditions different from arm's length conditions (the basis for a transfer pricing adjustment) if it lacks certain conditions that would have been included had the parties been dealing with one another at arm's length in comparable circumstances.

2 Budget 2025 does not provide any indication of the taxpayers or transactions that may be eligible for these streamlined reporting procedures.

The foregoing provides only an overview and does not constitute legal advice. Readers are cautioned against making any decisions based on this material alone. Rather, specific legal advice should be obtained.

© McMillan LLP 2025