1. Substance over form

Budget 2025 specifies that an analysis of transactions between a Canadian taxpayer and a non-resident non-arm’s length party must involve evaluation of whether the transaction includes actual conditions different from arm’s length conditions. The actual conditions are determined not only by contractual terms but also by considering ‘economically relevant characteristics’ which include the actual conduct of the party.

These economically relevant characteristics include the following five comparability factors, which are aligned with the OECD guidelines:

• ✓ Contractual terms;
• ✓ Functions performed, assets used, and risks assumed;
• ✓ Characteristics of the property or service;
• ✓ Economic and market context; and
• ✓ Business strategies.

The framework emphasizes substance over form, requiring that the controlled transaction be assessed in light of the participants’ actual conduct and the full set of economically relevant characteristics, ensuring that transfer pricing analyses reflect economic reality rather than just legal documentation.

2. Consistency with OECD Guidelines

A new interpretive rule would require that the identification of arm’s length conditions and any resulting adjustments be made to best achieve consistency with the OECD Transfer Pricing Guidelines (as published on January 7, 2022), unless otherwise prescribed by regulation.

This ensures alignment with existing international standards while preserving flexibility for the government to prescribe other aspects through regulation.

3. Applying the Most Appropriate Method

The proposals introduce an explicit requirement that while determining whether the conditions of a controlled transaction are consistent with the arm’s length principle, one must apply the most appropriate transfer pricing method in accordance with the Transfer Pricing Guidelines (i.e. the OECD Guidelines or any text, as prescribed by the government). Although this reflects existing administrative practice, it would now become a legal requirement.

4. Transfer Pricing Adjustment rule

Under existing transfer pricing rules, when certain conditions are satisfied, an in-scope transaction may be replaced with the transaction that independent parties would have entered into at arm’s length under comparable terms and conditions.

As per the Budget 2025, where actual conditions differ from arm’s length conditions (the conditions that would have existed had the parties been dealing independently), the CRA may adjust amounts to reflect the appropriate arm’s length outcome. In exceptional cases, this could justify replacing or disregarding a transaction entirely, ensuring consistency with OECD guidance.

Under the new framework, the authority to disregard or substitute transactions would be incorporated directly into the broader definition of “arm’s length conditions”. While Budget 2025 emphasizes that this recharacterization should apply only in “exceptional circumstances,” consistent with the OECD Transfer Pricing Guidelines and the interpretive rule, the revised approach still marks a clear expansion of the CRA’s authority compared to the current rules.

5. Key Administrative changes

Budget 2025 has introduced certain administrative changes to ensure efficient transfer pricing audits by the CRA as well as reduce compliance burden on taxpayers:

• ✓ Higher Penalty Threshold: The threshold for applicability of transfer pricing penalty has been increased from a transfer pricing adjustment of CAD 5 million to CAD 10 million, providing some relief for smaller taxpayers/adjustments.
• ✓ Faster Documentation submission: Taxpayers must provide transfer pricing documentation within 30 days of a CRA request, replacing the existing 3-month period, emphasizing the need for contemporaneous documentation. However, there is no change in the requirement to actually maintain the documentation by the tax return filing date for the respective year.
• ✓ Simplified Documentation Regime: Simplified documentation requirements will be applicable for eligible taxpayers, thereby reducing their administrative burden. The conditions for eligibility are yet to be prescribed.
• ✓ Aligning documentation requirements with the new changes: Clarifying transfer pricing documentation requirements and aligning them with updated definitions (including analysis of economically relevant characteristics, actual conduct of the parties and the requirement for selection of the most appropriate method). This would expand the existing documentation requirements to a great extent.