By Sharad Gondaliya, CPA
When a foreign company opens a Canadian subsidiary, most of the tax risk sits in the transactions between the two. Management fees, product purchases, loans and shared costs all cross the border. CRA expects each one to be priced and documented as if the companies were strangers.
Transfer pricing: the arm’s-length rule
The Income Tax Act requires transactions with non-arm’s-length non-residents to use terms that arm’s-length parties would accept. If CRA disagrees with your pricing, it can adjust the Canadian corporation’s income.
Common transactions to price:
- products bought from the parent for resale in Canada
- management, IT or head-office services charged by the parent
- services the Canadian corporation provides to the parent
- royalties for brands, software or know-how
- interest on intercompany loans
Documentation protects you from penalties
CRA can charge a transfer pricing penalty of 10% of large net adjustments. The penalty does not apply if you made reasonable efforts to set arm’s-length prices. In practice, that means documentation prepared by the T2 filing-due date and given to CRA promptly when it asks.
At a minimum, keep:
- Written intercompany agreements for each type of transaction.
- A description of what each company does, owns and risks.
- The pricing method and the data behind it.
- Invoices that match the agreements.
Form T106
| Requirement | Rule |
|---|---|
| Who files | Corporations with reportable transactions with non-arm’s-length non-residents |
| Threshold | Total reportable transactions above $1,000,000 in the year |
| Slips per non-resident | Separate slip for each non-resident above $100,000 |
| Due date | Same as the T2 return |
Late or missing T106 forms carry their own penalties, even when no tax is owed.
Thin capitalization
Funding the subsidiary with loans from the parent instead of share capital is common. The thin capitalization rules limit the interest deduction when debt owed to specified non-residents exceeds 1.5 times their equity in the corporation. Interest on the excess is not deductible and is treated as a dividend, which carries Part XIII withholding.
Keep the debt-to-equity ratio inside 1.5 to 1, or plan for the tax cost.
Loans from the subsidiary to the parent or owner
Money moving the other way is riskier. A loan from the Canadian corporation to a non-resident shareholder that is not repaid within one year after the corporation’s year-end can be treated as a dividend. Part XIII withholding then applies. Please speak with us before the subsidiary lends money to the parent or an owner.
Withholding on payments to the parent
| Payment to the parent | Withholding |
|---|---|
| Dividends | 25%, reduced by treaty |
| Interest on related-party loans | 25%, reduced by treaty |
| Royalties | 25%, reduced by treaty |
| Management and administration fees | 25%, often reduced or removed by treaty |
Each payment needs an NR4 slip. Directors can be personally liable for unremitted withholding.
How we help
We set up the intercompany agreements, keep the subsidiary’s books in Canada, prepare the T106, calculate withholding and file the NR4 slips. We work with your parent company’s finance team so both sides record the same amounts. Related reading: Canadian corporation for foreign entrepreneurs.
FAQs
Is there a revenue level below which transfer pricing does not apply?
No. The arm’s-length rule applies from the first dollar. The T106 threshold only decides whether the information form is filed.
Can the parent simply charge a percentage of sales as a management fee?
Only if that rate is supported as arm’s length. A fee with no evidence of real services is a common audit adjustment.
Should we fund the subsidiary with debt or equity?
It depends on cash needs, treaty rates and the thin capitalization limit. Please plan this before the first transfer.
Speak with a CPA
Please book a free consultation at gondaliyacpa.ca/consultation. We are a 2026 Xero Awarded Firm with 1300+ five-star Google reviews, and we work on AFFORDABLE flat-fee annual packages.
Sharad Gondaliya is a CPA Canada & CPA USA with 15 Years+ experience of Accounting, Tax, Payroll of Corporate Small Businesses as Tax Accountant. He is a CPA Ontario member (61040184) and holds US CPA licences in Washington and Montana and is well known among corporate small businesses for tax planning, efficient tax solutions, and affordable CPA services. Sharad is the Principal (Director) of Gondaliya CPA – Affordable CPA Firm in Canada. Licenses: CPA Ontario: 61040184 | CPA USA (MT): PAC-CPAP-LIC-033176 | CPA USA (WA): 57629 | CPA Firm License: 61330051 View Full Author Bio