Canada’s 2025 Federal Budget: Key international tax measures

Canada’s 2025 Federal Budget (“Budget 2025”) was light on international tax measures compared to recent years. The major development is the revamping of Canada’s transfer pricing rules following a public consultation process that began in 2021. A more targeted change is the extension of the foreign accrual property income (FAPI) regime to capture investment income earned by foreign affiliates to back Canadian insurance risks. The Government also reaffirmed its intention to proceed with a number of previously announced international tax measures that have yet to be enacted.

Transfer pricing overhaul

For tax purposes, transfer pricing rules govern the allocation of profits among the entities within a multinational corporate group. The accepted international standard for transfer pricing is the arm's length principle, as set out in the Organisation for Economic Co-operation and Development (“OECD”) Model Tax Convention (in Article 9) and in the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (the "OECD Transfer Pricing Guidelines").

Canada has its own set of domestic transfer pricing rules, which are contained in the Income Tax Act (Canada). Budget 2025 has proposed significant amendments to Canada’s transfer pricing regime to better align with the OECD Transfer Pricing Guidelines and the international articulation of the arm’s length principle. These reforms respond to consultations initiated in 2021 and reflect positions outlined in Finance’s lengthy 2023 consultation paper.

The proposed amendments provide more detailed guidance on how to interpret and apply Canada’s transfer pricing rules. Key elements of the proposed amendments include the following;

• Application of transfer pricing rules: Budget 2025 provides that the operative transfer pricing adjustment rule will apply where transactions between non-arm’s length parties include “actual conditions” that are different from “arm’s length conditions”, as determined with reference to “economically relevant characteristics” of the transactions.
  
  To provide greater clarity, the amendments will contain definitions for each of these terms. In particular, the term “economically relevant characteristics” of a transaction or series will be defined to include five comparability factors: (1) contractual terms, (2) functional profile (e.g. assets used and risks assumed, surrounding circumstances, and industry practices), (3) characteristics of the property or service, (4) economic and market context, and (5) business strategies pursued by participants.


• Incorporation of OECD Transfer Pricing Guidelines: The proposed amendments will include interpretive provisions that specifically require Canada’s transfer pricing rules to be interpreted and applied in a way that best achieves consistency with the OECD Transfer Pricing Guidelines.


• Relief for transfer pricing penalty: Under the current rules, a taxpayer faces a potential penalty where the net adjustment amount under the transfer pricing rules exceeds the lesser of (i) 10% of gross revenue or (ii) $5 million. The proposed amendments provide some relief by increasing the $5 million threshold to $10 million.


• Clarification of contemporaneous documentation requirements: The language of transfer pricing contemporaneous documentation requirements is revised to provide more detailed guidance, and the deadline to provide transfer pricing documentation to the Minister is reduced from three months to 30 days.
  
  A separate subsection is added to provide for simplified documentation requirements when prescribed conditions are met.

The new rules would apply to taxation years that begin on or after Budget Day in 2025 (November 4, 2025).

FAPI – Investment income from assets backing Canadian insurance risks

Canada’s tax system includes anti-deferral rules referred to as the foreign accrual property income (“FAPI”) rules, which are intended to prevent Canadian-parented multinational corporate groups from avoiding Canadian tax by earning certain types of income through controlled foreign affiliates. Under the FAPI rules, income characterized as FAPI and earned by a controlled foreign affiliate is immediately included in the income of the Canadian shareholder and subject to tax. This immediate income inclusion occurs regardless of whether such FAPI income has actually been distributed to the Canadian shareholder.

In this context, there is a particular rule pertaining to insurance businesses involving Canadian risks— i.e., risks in respect of Canadian resident persons, property situated in Canada, or business carried on in Canada. Under those rules, income earned by a foreign affiliate from such insurance business is specifically to be included in computing the foreign affiliate’s FAPI.

One of the core activities of an insurance business is to invest funds collected through insurance premiums, and use the resulting investment income to support claims arising on the occurrence of insured events. These investment assets may be held by the insurer directly, but often it is a foreign affiliate of the insurer that holds the assets.

Some taxpayers have argued that the existing FAPI rule for investment businesses does not apply to such investment income from investment assets held by foreign affiliates. Budget 2025 proposes a legislative clarification: that investment income earned by a foreign affiliate from assets used to support Canadian insurance risks is included in FAPI, regardless of which entity holds those assets.

The new rules would apply to taxation years that begin on or after Budget Day in 2025 (November 4, 2025).

Previously announced measures

Budget 2025 reiterates the Federal Government’s intention to proceed with the proposed amendments to the Global Minimum Tax Act, including those related to the “undertaxed profits rule” component of Pillar Two framework. No mention is made of the G7 countries’ (including Canada’s) announcement on June 28, 2025 to adopt a “side-by-side system” to accommodate the opposition of the United States to having U.S.-parented groups subject to another country’s “undertaxed profits rule”.

Budget 2025 also confirms that the Government still plans to implement the OECD’s Crypto-Asset Reporting Framework and to update Canada’s Common Reporting Standard rules in line with international standards, though it notes that there may be a deferred application date of January 1, 2027.

Budget 2025 includes the caveat that all previously announced measures that the government plans to proceed with may be modified to take into account consultations and deliberations since their release.