Group taxation is not permitted.
Canadian transfer pricing legislation and administrative guidelines are generally consistent with the OECD Guidelines. Statutory rules require that transactions between related parties be carried out under arm's-length terms and conditions. The CRA has indicated that it will apply the revised OECD guidance on transfer pricing by multinational enterprises (MNEs) arising from the base erosion and profit shifting (BEPS) project (the BEPS final report was issued October 2015; see Base erosion and profit shifting [BEPS] in the Tax administration section for more information). The government’s view is that the revised guidance is generally consistent with the CRA’s interpretation and application of the arm’s-length principle and that, consequently, CRA audit practices are not expected to change significantly.
On 26 September 2018, the Tax Court of Canada (TCC) issued its decision on a transfer pricing court case involving Cameco Corporation. The decision provides important guidance on the application of Canada’s transfer pricing recharacterisation rules, the use of hindsight in determining transfer prices, and the significance of contractual terms; and some insight can be inferred for their implications relating to transfer pricing documentation. Certain of the principles set out in the TCC decision are already proliferating current dialogue in the Canadian transfer pricing landscape.
Penalties may be imposed on adjustments to income if contemporaneous documentation requirements are not met. A taxpayer will be deemed not to have made reasonable efforts if the taxpayer does not maintain complete and accurate documentation to evidence that it has determined and used arm's-length prices for its related-party transactions. The documentation must be prepared and be complete in all material respects on or before the taxpayer's documentation due date, which is six months after the end of the taxation year for corporations.
The transfer pricing penalty is 10% of the transfer pricing adjustment if the adjustment exceeds the lesser of CAD 5 million and 10% of the taxpayer's gross revenue for the year. The penalty is not deductible in computing income, applies regardless of whether the taxpayer is taxable in the year, and is in addition to any additional tax and related interest penalties.
Canada has an Advance Pricing Arrangement (APA) program that is intended to help taxpayers obtain a level of certainty on transfer prices acceptable to the local tax authorities and, when negotiated as bilateral or multilateral APAs, with tax authorities in other jurisdictions.
Many of Canada's international tax agreements contain provisions concerning income allocation in accordance with the arm's-length principle. These include a Mutual Agreement Procedure, which is a treaty-based mechanism through which taxpayers can petition competent authorities for relief from double taxation resulting from transfer pricing adjustments. The OECD's Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (also known as the Multilateral Instrument [the MLI]) entered into force for Canada on 1 December 2019 and applies to some of Canada's tax treaties as early as 1 January 2020 (see Treaty shopping in the Tax administration section for more information).
Transfer pricing adjustments
When the Canadian transfer pricing rules have applied to adjust, for tax purposes, amounts related to transactions between a Canadian corporation and one or more non-arm’s length non-residents (a ‘primary adjustment’), the related benefit to the non-residents is treated by the CRA as a deemed dividend (a ‘secondary adjustment’), subject to WHT, which can be eliminated, at the discretion of the Minister of Revenue, if the amount of the primary transfer pricing adjustment is repatriated to the Canadian corporation.
Draft legislative proposals introduce an ordering rule, which clarifies that adjustments resulting from the transfer pricing rules must be made before applying any other provisions of the Income Tax Act, for taxation years beginning after 18 March 2019. This ordering could affect the determination of penalties under the transfer pricing rules. It does not affect the existing exemption from the transfer pricing rules for certain loans and guarantees provided by Canadian-resident corporations to controlled foreign affiliates.
Country-by-country (CbC) reporting
Annual CbC reporting is required for MNEs with total annual consolidated group revenue of 750 million euros (EUR) or more (approximately CAD 1 billion). To facilitate the sharing of this information with its international treaty partners, Canada, along with 83 other jurisdictions, has signed the OECD’s Multilateral Competent Authority Agreement on CbC reporting. The reporting includes key metrics for each country the MNE operates in, such as: revenue, profit, tax paid, stated capital, accumulated earnings, number of employees, and tangible assets, as well as a description of the main activities of each of its subsidiaries. The reporting is due within one year of the end of the fiscal year to which the report relates. The first exchanges between jurisdictions of CbC reports occurred in July 2018. Before any such exchanges, the CRA will have formalised an exchange arrangement with the other jurisdiction and ensured that appropriate safeguards are in place to protect the confidentiality of the reports. Form RC4649 ‘Country-by-Country Report’ is the CRA's reporting form that follows the CbC reporting format recommended by the OECD in its October 2015 BEPS report on transfer pricing documentation and CbC reporting. Publication RC4651 (E) ‘Guidance on Country-By-Country Reporting in Canada' provides further guidance that is generally consistent with the OECD’s recommendations, but includes several differences.
It is important to determine a Canadian entity’s CbC report filing obligation by identifying whether Canada has a qualified competent authority agreement with a particular country for purposes of exchanging CbC reports. If this agreement does not exist, a Canadian MNE must file a CbC report in Canada as a constituent entity, even if a CbC report has been prepared and filed by an ultimate parent entity or a surrogate parent entity in that particular country.
Canada and the United States have signed a bilateral competent authority arrangement to allow for the exchange of CbC reports. The reports should be exchanged no later than 15 months after the year end of an MNE group.
Thin capitalisation rules can limit interest deductions when interest-bearing debt owing to certain non-residents (or persons not dealing at arm's length with certain non-residents) exceeds one and a half times the corporation’s equity. The rules also apply to debts owing by:
- a partnership of which a Canadian-resident corporation is a member
- Canadian-resident trusts, and
- non-resident corporations and trusts that operate in Canada.
Disallowed interest is treated as a dividend paid to the non-residents and subject to WHT.
Back-to-back loan arrangements
The Canadian Income Tax Act contains ‘back-to-back loan’ rules that prevent taxpayers from interposing a third party between a Canadian borrower and a foreign lender to avoid the application of rules that would otherwise apply if a loan were made directly between the two taxpayers. The back-to-back loan rules ensure that the amount of WHT on a cross-border interest payment cannot be reduced through the use of back-to-back loan arrangements. Anti-avoidance provisions also apply to certain back-to-back loan arrangements undertaken by taxpayers using an interposed third party:
- in the thin capitalisation rules for taxation years that begin after 2014, and
- relating to WHT on interest payments for amounts paid or credited after 2014.
In addition, these back-to-back loan rules:
- apply to cross-border payments of rents, royalties, or similar payments made after 2016 (an exception is available for certain arm’s-length royalty arrangements that do not have a main purpose of avoiding WHT)
- include character substitution rules so the back-to-back loan rules cannot be avoided through the substitution of economically similar arrangements between the intermediary and another non-resident person, for interest and royalty payments
- apply to back-to-back shareholder loan arrangements that are outstanding after 21 March 2016 (if there are multiple intermediaries), and
- apply to back-to-back arrangements involving multiple intermediaries, for interest and royalty payments made after 2016, and for shareholder debts as of 1 January 2017.
Controlled foreign affiliates and foreign accrual property income (FAPI)
Under Canada’s FAPI rules, Canadian corporations are taxed on certain income of controlled foreign affiliates (typically, certain income from property, income from a business other than active, income from a non-qualifying business, and certain taxable capital gains) as earned, whether or not distributed. A grossed-up deduction is available for foreign income or profits taxes and WHTs paid in respect thereof. In general, a foreign corporation is a foreign affiliate of a Canadian corporation if:
- the Canadian corporation owns, directly or indirectly, at least 1% of any class of the outstanding shares of the foreign corporation, and
- the Canadian corporation, alone or together with related persons, owns, directly or indirectly, at least 10% of any class of the outstanding shares of that foreign corporation.
The foreign affiliate will be a controlled foreign affiliate of the Canadian corporation if certain conditions are met (e.g. more than 50% of the voting shares are owned, directly or indirectly, by a combination of the Canadian corporation, persons at non-arm’s length with the Canadian corporation, a limited number of Canadian-resident shareholders, and persons at non-arm’s length with those Canadian-resident shareholders).
Income from an ‘investment business’ of a foreign affiliate is generally included in its FAPI. When the income attributable to specific activities carried out by a foreign affiliate accrues to a specific Canadian taxpayer under a tracking arrangement, such activities are deemed to be a separate business, for taxation years of a taxpayer’s foreign affiliate beginning after 26 February 2018. Each separate business will need to meet specific conditions, including the ‘six employees’ test, to be excluded from the investment business definition.
When the principal purpose of a business carried on by an affiliate is to derive income from trading or dealing in indebtedness, the income from that business is generally included in its FAPI. Certain minimum capital requirements apply to the trading or dealing in indebtedness rules for an affiliate to qualify for the regulated foreign financial institution exception, for taxation years of a taxpayer’s foreign affiliate beginning after 26 February 2018.
Controlled foreign affiliate status
A foreign affiliate of a taxpayer is deemed to be a controlled foreign affiliate of the taxpayer if FAPI attributable to specific activities of the foreign affiliate accrues to the benefit of the taxpayer under a tracking arrangement.