Canada's 2025 Budget Proposes Major Transfer Pricing Changes

Introduction

On November 4 Canadian Prime Minister Mark Carney's minority federal Liberal government published¹ its first budget.² That budget includes the most important amendments to Canada's modern transfer pricing rules since their enactment nearly 30 years ago. This article critically reviews those proposals against the background of existing law.

Background

Canada's modern transfer pricing rules were enacted in 1998³ in the Canadian Income Tax Act.⁴ The operative provision at subsection 247(2) adopts a two-pronged approach.⁵

First, the main rule, found in paragraphs (a) and (c), provides that, where a taxpayer and a nonresident person with whom the taxpayer does not deal at arm's length are participants in a transaction or a series of transactions and the terms or conditions of the transaction or series differ from those that would have been made between persons dealing at arm's length, any amounts that would be determined for the purposes of applying the provisions of the ITA must be adjusted to the quantum that would have been determined if the terms and conditions made or imposed, in respect of the transaction or series, between the participants in the transaction or series had been those that would have been made between persons dealing at arm's length.⁶ In short, this is Canada's basic repricing rule. For example, if a Canadian company manufactures widgets and distributes them in Europe through an Irish subsidiary, the Canadian company may wish to reduce its profits taxable at, say, 25 percent in Canada by lowering its wholesale price to the Irish subsidiary, thereby generating inflated resale profits in Ireland taxable at 12.5 percent. This is the oldest trick in the playbook, and paragraphs 247(2)(a) and (c) require an adjustment to the transfer price on this transaction to an arm'slength price.

Second, the exceptional antiavoidance recasting rule, found in paragraphs (b) and (d), provides that, if the transaction or series would not have been entered into between persons dealing at arm's length and can reasonably be considered not to have been entered into primarily for bona fide purposes other than to obtain a tax benefit, any amounts that would be determined for the purposes of applying the provisions of the ITA in respect of the taxpayer must be adjusted to the quantum or nature of the amounts that would have been determined if the transaction or series entered into between the participants had been the transaction or series that would have been entered into between persons dealing at arm's length, under terms and conditions that would have been made between persons dealing at arm's length.⁷ This exceptional rule is intended to attack tax-motivated commercially irrational transactions that cannot practically be repriced. In the example above, if the Canadian parent donated its proprietary widget-manufacturing technology to its Irish subsidiary to minimize the group's taxes going forward,⁸ the government can use the recasting rule to change the donation into a sale (or possibly a license) for arm's-length consideration.⁹

After suffering court defeats in several highprofile cases, most notably in Cameco, ¹⁰ the government became increasingly frustrated with the operation of section 247.¹¹ Cameco involved a Canadian uranium producer that established a Swiss uranium trading company. The Federal Court of Appeal (FCA) held that while the Canadian parent's prices for the sale of uranium to its Swiss subsidiary were tax-motivated, there was no sham; the recasting rule did not apply, and the repricing rule did not change the taxpayer's transfer prices, as they were found to be within an arm's-length range. The government particularly disliked the holding in Cameco that paragraphs 247(2)(b) and (d) apply an objective test based on hypothetical persons, not the taxpayer, and require that no arm's-length persons would have entered into that transaction under any terms and conditions.¹²

This led to the announcement in the 2021 budget of a consultation on major amendments to the transfer pricing rules. At the time, the government stated the following:

The government's commitment to this process was reiterated in later budgets, and Budget 2025 has now finally proposed the enactment of the rules for taxation years beginning after the budget date.¹⁴

Critical Review of the Proposed Rules

Consistent with legislative drafting convention followed by the Department of Finance, the rule in current section 247(2) will be split into an application provision, to be found in new section 247(2), and an operative rule, to be found in new section 247(2.02).

The application conditions in proposed section 247(2) are that section 247(2.02) applies when the taxpayer and a nonresident person with whom the taxpayer does not deal at arm's length are participants in a transaction or series of transactions, and the actual conditions of the transaction or series include conditions different from arm's-length conditions. Superficially, this provision does not appear materially different from a stitched-together version of the relevant parts of current section 247(2).

However, the devil is in the details. A set of new reading rules and definitions applies to this provision, which creates a fundamental change in Canada's transfer pricing system. At the outset, there is a new section 247(1.1), which provides that for the purposes of the transfer pricing rules in general, a transaction or series of transactions is to be analyzed and determined (prior versions of the proposal used the term "delineated"), by referring to the "economically relevant characteristics" of the transaction or series.

The expression "economically relevant characteristics" is defined at section 247(1) by reference to a nonexhaustive list of items. Paragraph (a) of the definition refers to the contractual terms of the transaction or series, as well as the contractual terms of each other transaction or series that is relevant to the transaction or series and that involves at least one of the participants or any other member of the multinational enterprise group, but in any event only to the extent that such contractual terms are consistent with the actual conduct of the participants in the transaction or series.

There are two takeaways from this first item. First, the government explicitly positions the possibility of a sham challenge to the taxpayer's transactions(such as the one it unsuccessfully tried in Cameco) or, at a minimum, an allegation that the legal form is different from the actual legal substance of the transaction, by highlighting the chance of inconsistency between contractual terms and the actual conduct of the parties.

Second, the first item in the definition of economically relevant characteristics requires analysis not only of the contractual terms of the relevant transaction or series, but also of each other transaction or series that is relevant to the transaction or series and that involves at least one of the participants or any other member of the MNE group. This appears to require a U.S.-style economic substance analysis of the relationship, whereby several related transactions may be compressed into a single economic whole. What comes to mind here is the inbound hybrid financing structure described cryptically in the Canada Revenue Agency (CRA) Notice to tax professionals, dated July 5, 2019, which noted that the CRA had settled a matter under the recasting rule at paragraphs 247(2)(b) and (d).¹⁵ The structure, which was popular before the adoption of Canada's anti-hybrid rules, involved a Canadian subsidiary of a U.S. parent borrowing from it at interest in conjunction with a forward subscription agreement entered into by a sister subsidiary backstopped by a support agreement with the U.S. parent. While Canada's legal substance approach would normally require treating the various legal relationships separately, the United States would compress them into a single economic relationship. What paragraph (a) of the definition of economically relevant characteristics seems to now require is something like the U.S. approach.

Paragraph (b) of the definition of economically relevant characteristics focuses on the actual conduct of the participants in the transaction or series. In particular, it refers to the functions performed by those participants, considering assets used and risks assumed, how those functions relate to the wider generation of value by the MNE group to which the participants belong, the circumstances surrounding the transaction or series, and industry practices. This multifaceted criterion appears to seek to import both the traditional "functions, risks and capital" transfer pricing analysis as well as the approach taken by the OECD since the beginning of the base erosion and profit-shifting project over 10 years ago, which highlights the quest for the locus of the value-generating activities of the MNE group.

Paragraph (c) of the definition refers to the characteristics of any property transferred or service provided. This seems to draw out a distinction between high-value intangibles and services and other properties and services.

Finally, paragraph (d) of the definition refers to the economic circumstances of the participants and the market in which they operate, while paragraph (e) refers to the business strategies pursued by the participants.

It's obvious from the above that the new section 247(1.1) and the definition of economically relevant characteristics substantially dilute Canada's legal substance approach to the characterization of transactions for tax purposes,¹⁶ and front-load into the transfer pricing analysis of the new section 247, a multifaceted economic substance approach that has thus far been foreign to Canadian tax law.

Another key notion in proposed paragraph 247(2) is that of "arm's length conditions," which is defined as the conditions that would have applied had the participants been dealing at arm's length in comparable circumstances, including the possibility that no transaction or series, or a different transaction or series, would have been concluded had the participants been dealing at arm's length in comparable circumstances. This definition seems clearly intended to override the holding in Cameco that paragraphs 247(2)(b) and (d) apply an objective test based on hypothetical persons, not the particular taxpayer, and require that no arm's-length persons would have entered into that transaction under any terms and conditions. The definition of arm's-length conditions focuses the analysis on the actual participants to the transaction, and while it posits arm's-length dealings, it requires them to be set in comparable circumstances. Also, the definition highlights the possibility that no transaction would have been entered into had the parties been dealing at arm's length, or that a completely different transaction would have been struck. All of this seems driven by the government's dislike of Cameco, but unfortunately ignores that MNE groups often engage, quite properly and without tax motivations, in intragroup dealings that are unlike what may have happened had the same parties been dealing at arm's length in the same circumstances.

Another proposed provision, subsection 247(1.2), is a general interpretation rule that states that for the purposes of the definitions of actual conditions and arm's-length conditions, the word "conditions" is to be interpreted broadly and includes price, rate, gross margin, net margin, the division of profit, contributions to costs, and any commercial or financial information relevant to the determination of the quantum or nature of initial amounts or adjusted amounts, as the case may be.

All of this feeds into the new operative rule in proposed section 247(2.02), which broadly provides that any amounts that would be determined for the purposes of applying the provisions of the ITA regarding the taxpayer must be adjusted to the quantum or nature of the amounts that would have been determined if arm's-length conditions regarding the transaction or series had applied.¹⁷ This rule effectively merges former paragraphs 247(2)(c) and (d) and, most importantly, omits the antiavoidance features of the current recasting rule of paragraphs 247(2)(b) and (d). This puts recasting — and now, explicitly, rejection — of a non-arm'slength transaction on par with repricing, thereby normalizing what would otherwise be an extraordinary remedy. Budget 2025 states that "in accordance with the transfer pricing guidelines, and consistent with the interpretation rule, an inscope transaction or series accurately analyzed and determined should be replaced with an alternative transaction or series, or no transaction or series at all, only in exceptional circumstances."¹⁸ Unfortunately, the redrafted transfer pricing rules suggest the opposite. The author hopes that the government will adjust the drafting in accordance with the policy discussion above in Budget 2025.

Finally, regarding the interpretation rule previously mentioned, proposed subsection 247(2.03) states that for the purposes of determining the effect of the transfer pricing rules, the analysis and determination of a transaction or series of transactions under subsection (1.1), the identification of arm's-length conditions under paragraph (2)(b), and the determination of amounts under subsection (2.02) are to be made so as to best achieve consistency with the transfer pricing guidelines (defined as the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations),¹⁹ adopted by the Committee on Fiscal Affairs on January 7, 2022, unless a different text is prescribed by regulation. In addition, proposed subsection 247(2.04) states that whether a transaction or series of transactions includes actual conditions that differ from arm's-length conditions should be determined through an analysis in which the most appropriate method is selected and applied in accordance with the transfer pricing guidelines.

In Canada v. GlaxoSmithKline Inc., the Canadian Supreme Court held that the OECD transfer pricing guidelines are not controlling as if they were a Canadian statute, and that the test of any set of transactions or prices ultimately must be determined by the ITA rather than according to any particular method or commentary set out in the guidelines.²⁰ Proposed subsection 247(2.03) and (2.04) seem designed to chip away at the GlaxoSmithKline holding.

As this author has previously argued:

Proposed subsection 247(2.04), which was not included in the initial consultation package, is more concerning as it appears to override GlaxoSmithKline and impose an incorporation by reference into Canadian law of the transfer pricing methodologies outlined in the transfer pricing guidelines. To what extent Canadian courts will follow this remains to be seen, as the transfer pricing guidelines never perfectly match up with actual behavior within an MNE group, which may otherwise reflect arm's-length dealings.

Conclusion

The government's proposed redraft of Canada's transfer pricing rules is, in this author's view, ill-advised. Frustration with court losses is rarely a proper policy basis for legislative changes. Unfortunately, while the proposals appear more prescriptive on the surface, they actually increase the risk of uncertainty for taxpayers and lead to a significant rise in transfer pricing disputes. Of particular concern is the government's intention to make recasting and rejection of non-arm's-length transactions the new norm, thereby shifting the principal focus of transfer pricing away from repricing. Ultimately, the proposals ignore a simple reality about transfer pricing that was aptly captured by the late Justice Robert Hogan of the TCC: "Transfer pricing is largely a question of facts and circumstances coupled with a high dose of common sense."²²

Footnotes

1 "Canada Strong: Budget 2025" (Nov. 4, 2025); "Bill C-15: An Act to Implement Certain Provisions of the Budget Tabled in Parliament on November 4, 2025," at 93(19) (Nov. 4, 2025); "Canadian Government Publishes 2025 Budget," Tax Notes Today Int'l (Nov. 1, 2025).

2 Typically, the federal government publishes its budget in the spring of each year, but early 2025 saw quite a bit of political upheaval in Canadian federal politics as former Prime Minister Justin Trudeau had resigned and was replaced by Carney, who ultimately led the federal Liberal party to an unexpected reelection into government. Initially, the government hesitated to publish a budget in the latter part of 2025, but under pressure from opposition parties, it timed the budget for the fall, when previous governments typically issue their economic updates. The government has announced that future budgets will be timed in the fall. For commentary, see Ian Caines, Sabina Han, and Michael Kandev, "Canada's Budget Modernization Will Cause Headaches for Tax Pros," Bloomberg Tax (Oct. 30, 2025).

3 This initiative came after the OECD published its transfer pricing guidelines in 1995.

4 Income Tax Act, at art. 247 (Dec. 12, 1988).

5 See Brian Bloom and Francois Vincent, "Canada's (Two) Transfer Pricing Rules," at 20:1-40, 2011 CTF Conference Report (2011).

6 ITA, supra note 4, at art. 247(2)(a) and (c).

7 Id. at art. 247(2)(b) and (d). See also Bloom, "Paragraph 247(2)(b) Demystified," CCH Tax Topics No. 1783, 1-5 (May 11, 2006).

8 Assuming this is not structured as a capital contribution, which would not be exceptional in a corporate context.

9 ITA, supra note 4, at arts. 69, 247. Article 69(1) deems fair market value proceeds of disposition on a gift. But current subsection 247(2.1) gives priority to the transfer pricing rules in cross-border non-arm'slength situations, and this was also the case under former subsection 247(8), which gave priority to section 247 over section 69.

10 The Queen v. Cameco Corporation, 2020 FCA 112 (FCA 2020), leave to appeal to the Supreme Court of Canada (SCC) denied, No. 39368 (Feb. 18, 2021).

11 The government's frustration with Cameco is also apparent from its challenge to the taxpayer's structure in a second case group of cases, pending before the Tax Court of Canada (TCC), dealing with certain subsequent years. Cameco Corporation v. The King, 2024-1991(IT)G, 2021- 2686(IT)G, 2022-2715(IT)G, 2022-2717(IT)G, 2024-1992(IT)G.

12 The Queen v. Cameco Corporation, 2020 FCA 112, at paras. 43-44, 82.

13 "2021 Federal Budget," at 308 (Apr. 19, 2021).

14 "Bill C-15: An Act to Implement Certain Provisions of the Budget Tabled in Parliament on November 4, 2025," supra note 1, at section 93(19).

15 See "CRA Notice to Tax Professionals 5 July 2019," Tax Interpretations (July 5, 2019).

16 Shell Canada Ltd. v. Canada, 3 S.C.R. 622, at para. 39ff (SCC 1999).

17 A proposed reading rule in subsection 247(2.01) specifies that for the purposes of paragraph (2), a transaction or series of transactions is deemed to include actual conditions different from arm's-length conditions if a condition does not exist regarding the transaction or series, but would have existed had the participants in the transaction or series been dealing at arm's length in comparable circumstances.

18 "Canada Strong: Budget 2025," supra note 1, at 354.

19 OECD, "OECD Transfer Pricing Guidelines for Multinational Entities and Tax Administrations 2022" (Jan. 20, 2022).

20 Canada v. GlaxoSmithKline Inc., 2012 SCC 52, at paragraph 20. This was Canada's first modern transfer pricing case, which involved the government's unsuccessful challenge of the transfer price paid by the taxpayer for the active ingredient of the Zantac blockbuster drug.

21 Kandev, "Interpretation or Delegation: The Increasing Prevalence of Formal References to OECD Materials," 2(3) International Tax Highlights 9 (2023).

22 General Electric Capital Canada Inc. v. Canada, 2009 TCC 563, at para. 273.

Originally published by Tax Notes International, 15 December 2025, p. 1793

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