When a company does business with another company in the same group, such as a parent and its subsidiary. They will often charge each other for goods, services, or loans. These inside prices are called intercompany transactions. In Canada, transfer pricing rules govern those intercompany prices to make sure they’re fair and in line with what independent parties would charge.
In simple terms, transfer pricing in Canada ensures that related entities act as if they were independent. Moreover, treating each other as outside parties would help prevent tax avoidance. Transfer pricing is important to prevent tax base erosion and profit shifting among group entities in Canada.
These rules are enforced by the Canada Revenue Agency (CRA), guided by Section 247 of the Income Tax Act.
Key Legal Framework & Principles
Section 247 & CRA Transfer Pricing Guidelines
- Section 247 by CRA allows them to adjust intercompany prices to what they should have been under arm’s length terms.
- If the CRA determines that the pricing is not arm’s length. They can make transfer pricing adjustments and impose penalties.
- Under section 247(4), taxpayers must make efforts to comply. Failing to do so may trigger transfer pricing penalties in Canada.
The CRA publishes official guidance and memoranda explaining how they apply these rules. You can find their core guidelines on the CRA’s website.
Arm’s Length Principle
In Canada, the rule is that related parties must deal with each other as if they were unrelated. This is known as the arm’s-length principle. “Arm’s length” means the terms, conditions, price, and profit margin in a related-party transaction should match what independent parties would agree.
If the terms differ from those that would apply between independent parties, the CRA has the power to adjust the amount for tax purposes.
The rule typically applies to transactions between a Canadian entity and a non-resident related party (i.e., cross-border non-arm’s-length transactions). Domestic non-arm’s-length transactions may not fall under the same section.
Transfer Pricing Memoranda & CRA Practice
CRA’s Transfer Pricing Memoranda (TPMs) provide more detail in specific areas, such as
- TPM-05R2 on documentation
- TPM-09 on reasonable efforts
- TPM-03R on downward adjustments
These memos are not law, but are highly influential in how the CRA enforces.
Transfer Pricing Documentation in Canada
One of the most important requirements under Canadian transfer pricing rules is the documentation of transactions. You must prove and show your intercompany prices are defensible.
Contemporaneous Documentation
- Under section 247(4), you must create documentation by the time your tax return is filed.
- If CRA demands, you must provide it within three months.
- The documentation must include:
- Description of intercompany transactions
- Functions, assets, and risks of each party
- Benchmarking/comparables analysis
- Choice of transfer pricing method and adjustments
- Contracts, agreements, data, and support
If you fail to maintain all documentation, the CRA can challenge your pricing more easily.
Domestic Intercompany Exception
Interestingly, purely domestic intercompany transactions ( within Canada) generally aren’t subject to strict transfer pricing documentation rules. The focus of CRA is mostly on cross-border and international transactions.
Reporting Obligations
You must also report intercompany non-arm’s-length transactions:
- Form T106: For non-arm’s-length transactions with non-residents
- Form T1134: For controlled / non-controlled foreign affiliates
- Country-by-Country Report (CbC): For large multinational groups meeting revenue thresholds
Transfer Pricing Methods Used in Canada
To set or analyse intercompany pricing, Canada accepts several standard methods. Some key ones:
- Comparable Uncontrolled Price (CUP), Compare your controlled price with similar independent transactions
- The Resale Price Method starts from the price at which goods are resold and subtracts a margin.
- Cost Plus Method to add a markup to the cost to reach a fair price
- The Transactional Net Margin Method (TNMM) is used to compare the net margin against comparable firms
- Profit Split Method to split combined profits based on the contribution of each party
Choosing the right method depends on the nature of the transaction, availability of comparables, and your business model.
Common Transfer Pricing Methods in Canada
| Method | Description | Common Use |
|---|---|---|
| Add markup to the cost | Gross margin based on resale to a third party | Sale of goods |
| Resale Price Method | Add markup to the cost | Distributors |
| Cost Plus Method | Add markup to cost | Service providers, manufacturers |
| TNMM | Compare operating profit margin | Routine entities |
| Profit Split | Divide profit based on contribution | Integrated groups |
Audits, Adjustments & Penalties
CRA Audits & Transfer Pricing Adjustments
The CRA monitors intercompany transactions, especially internationally. If they find your pricing adjustment wasn’t following the arm’s length principle, they may:
- Make adjustments under section 247(2) to increase income and reallocate costs.
- Extend reassessment periods, up to 7 years in some cross-border cases.
- Deny deductions, re-characterise transactions
Penalties for Non-Compliance
If CRA finds that you didn’t follow section 247, you could face a 10% penalty on net transfer pricing adjustments. That’s why it’s important to take steps to avoid penalties. You must show that you followed accepted methods, used comparables, and maintained proper documentation.
How Businesses Can Ensure Compliance
To stay safe and avoid disputes:
- Get professional transfer pricing services in Canada as early as possible.
- Perform regular benchmarking studies and updates
- You need to maintain strong documentation in Canada
- Consider applying for the Advance Pricing Arrangements (APA) with CRA to get certainty
- Monitor CRA’s policy changes and TPM updates
- Respond promptly to audit requests
- Ensure proper transfer pricing compliance in Canada.
By staying proactive, you reduce audit risk and avoid penalties. Also, you can justify your intercompany pricing if challenged by being prepared beforehand.
Role of professional support
Transfer pricing in Canada is complex and carries significant risks. If your business engages in international or inter-company transactions, you cannot ignore these rules. From Income Tax Act section 247, to strict documentation requirements, audits, adjustments, and penalties, every part must be handled carefully.
If you want to avoid surprises and make sure your company stays compliant, contact Bestax. We offer expert transfer-pricing consultation and compliance services. We’ll help you build the right documentation and reduce your tax risk, so you can focus on growing your business.
Quick FAQs
What is transfer pricing in Canada?
Transfer pricing is a rule that governs how companies within the same corporate group set prices for goods, services, loans, or cost allocations.
How does the arm’s length principle apply in Canada?
It demands that related parties transact as if they were unrelated (In price, terms, risk, and conditions).
What are the transfer pricing documentation requirements in Canada?
In Canada, taxpayers must prepare contemporaneous documentation under the Income Tax Act. 247(4) for cross-border non-arm’s-length transactions, including details on terms, participants, functions, risks, methods, and assumptions. You must produce it if CRA asks (within about 3 months).
What are the penalties for non-compliance?
If you don’t make reasonable efforts under section 247, a 10% penalty on net adjustments may apply. Also, CRA may deny deductions or extend reassessments.
What are the key transfer pricing methods recognized in Canada?
CUP, Resale Price, Cost Plus, TNMM, and Profit Split are the major ones.
How does Canada enforce transfer pricing compliance?
They do it via CRA audits, reassessments, adjustments, penalty regime, and documentation requirements, especially in cross-border transactions.
What is country-by-country reporting, and does it apply in Canada?
CBC reporting requires large multinationals to allocate income, taxes, and operations by jurisdiction. In Canada, groups above certain revenue thresholds must satisfy this obligation.
Disclaimer: The information provided in this blog is for general informational purposes only. For professional assistance and advice, please contact experts.
