Canada has largely rewritten its transfer pricing framework, and the amended rules are in effect.
Statutory safeguards that restricted situations in which the Canadian tax authority could recharacterize a transaction for transfer pricing purposes were removed from the legislation. Some concern has been expressed that this change might give the government more scope to assess taxpayers.
But two significant forces—the constraints embedded in the OECD’s Transfer Pricing Guidelines and the longstanding history of judicial restraint in this area—should continue to bear on tax authorities to mitigate the impact of this change.
Recharacterization Still Exceptional
Canada’s stated intention in amending its transfer pricing rules was to bring them “in line with the international consensus on the application of the arm’s length principle.”
Among the reforms is a “consistency” rule that requires fundamental aspects of a transfer pricing analysis to be carried out “so as to best achieve consistency with” the Organization for Economic Cooperation and Development’s guidelines. This is the first time the guidelines have been explicitly incorporated into Canadian legislation.
The transfer pricing guidelines from the OECD mirror the restrictive approach to recharacterization that was explicit in the previous legislation. They state that recharacterization should be reserved for “exceptional circumstances” and that “every effort” should be made to price the actual transaction first. They go on to say that non-recognition of a taxpayer’s agreement can be “contentious,” a “source of double taxation,” and that the decision to recharacterize should center on an assessment of the “commercial rationality” of the transaction.
So, while the Canadian legislation itself no longer contains the same explicit safeguard against recharacterization, the OECD guidelines contain language to a similar effect. The consistency rule should ensure that the guidelines impose the requisite discipline on a recharacterization analysis under the new regime.
Role of Judiciary
Canadian courts also won’t interpret the rewritten rules from a blank slate. Historically, the courts have respected legal relationships that reflect commercial substance and have been reluctant to recharacterize them, barring exceptional circumstances.
This principle runs through the leading Canadian cases in both the transfer pricing context, such as GlaxoSmithKline, and in the law more generally, such as in Shell Canada Ltd.
Under the previous transfer pricing framework, the courts would determine the relationship between the parties consistently with both the OECD guidelines and the foundational principles of Canadian tax law—starting with reference to the written agreements and accounting for evidence of the parties’ actual conduct. The courts also respected the hard line between pricing and recharacterization when making any adjustments. That should remain the case.
Courts would consistently show deference to business judgment by focusing on whether the pricing in question was within an arm’s length range and not whether a particular structure was optimal or tax neutral.
These principles have developed over decades of jurisprudence and are also likely to remain instructive in a recharacterization analysis under the amended regime.
Looking Ahead
Canada’s transfer pricing framework may have been rewritten. But as a practical matter, the changes will be constrained by both the international consensus and domestic legal traditions.
Canadian courts are unlikely to abandon longstanding judicial approaches overnight, particularly because the OECD guidelines themselves limit how expansively the new provisions can be applied. The result may be a legal regime that provides new pathways to similar or only incrementally different outcomes, rather than a seismic shift in Canadian transfer pricing.
This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law, Bloomberg Tax, and Bloomberg Government, or its owners.
Author Information
Pooja Mihailovich is a partner at Blakes and co-leads the tax controversy and litigation group.
Erich Schultze is an associate at Blakes and specializes in resolving tax disputes.
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