Torys on Budget 2025: tax highlights

What you need to know

• Transfer pricing. Budget 2025 proposes to replace the existing transfer pricing rules with a new framework that, among other things, alters the current recharacterization rule and incorporates the Organisation for Economic Co-operation and Development’s (OECD) Transfer Pricing Guidelines.
• Qualified investments for registered plans. Budget 2025 proposes to expand the types of investments that registered plans can hold by replacing the existing rules with two new categories of “Qualified Investments”. These new rules are expected to provide registered plans with better access to pooled fund investments.
• Clean technology and green energy measures. Budget 2025 proposes several measures relating to clean energy investment tax credits, such as extending the full Carbon, Capture, Utilization and Storage Investment Tax Credit and expanding the list of critical minerals that are eligible for the Clean Technology Manufacturing Investment Tax Credit.
• Other measures. Other measures proposed in Budget 2025 include immediate expensing for manufacturing and processing buildings, extending the Mineral Exploration Tax Credit, key changes to the SR&ED program, new rules that further restrict the deferral of Part IV tax and confirming the government’s intention with respect to certain tax proposals that were previously announced.

International income tax measures

Transfer pricing

Canadian transfer pricing rules seek to ensure that income that should be taxed in Canada is not shifted to foreign jurisdictions by pricing transactions in a manner that reduces Canadian profits. To that end, transfer pricing rules require Canadian-resident taxpayers who deal with non-arm’s length non-residents of Canada to transact using arm’s length prices. The transfer pricing rules generally impose arm’s length terms and conditions in respect of these transactions (or series of transactions).

Budget 2025 proposes the first major amendment to the Tax Act’s transfer pricing regime since its enactment in 1998. The proposals would replace key components of the existing legal tests with a new analytical framework to expressly adopt the OECD’s Transfer Pricing Guidelines, and to amend elements of the contemporaneous documentation regime relating to transfer pricing penalties. Below is an overview of selected key changes.

The existing rule

The existing transfer pricing rule has two branches:

• Pricing rule: The first branch applies where the terms or conditions made or imposed in a transaction or series of transactions in which non-arm’s length parties participate differ from those that would have been made between persons dealing at arm’s length. In such a case, an adjustment would be made to the pricing to reflect the terms and conditions that would have been made between persons dealing at arm’s length.
• Recharacterization rule: The other branch of the rule applies where the transaction or series of transactions would not have been entered into between persons dealing at arm’s length, and it could reasonably be considered not to have been entered into primarily for bona fide purposes other than to obtain a tax benefit. In such a case, an adjustment would be made to the pricing to reflect the transaction or series of transactions 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.

Courts have issued several significant decisions interpreting these branches. Parliament was particularly concerned with the Federal Court of Appeal’s interpretation of the recharacterization rule in Canada v. Cameco Corporation¹. After the Supreme Court rejected leave to appeal that decision, Budget 2021 announced a consultation that continued with a consultation paper in 2023.

The proposed analytical framework

The proposed analytical framework dispenses with the two separate branches, creating a single adjustment while eliminating certain legal tests that exist under the current rule.

The new transfer pricing rule would apply if two conditions are met:

1. there is a transaction or series of transactions in which non-arm’s length parties participated; and
2. the transaction or series (once it has been analyzed and determined) includes actual conditions different from arm's length conditions. The actual conditions are determined not only by the contractual terms of the transaction or series, but also by other “economically relevant characteristics”, including the conduct of the participants.

Budget 2025 states that the new definition of “arm’s length conditions” poses the question of “what the actual participants to the in-scope transaction or series would have done if they had been dealing at arm’s length, and not what other theoretical parties dealing at arm's length might have done”². This new position effectively overturns Cameco’s interpretation of the original recharacterization rule.

According to Budget 2025, the word “conditions” should be interpreted broadly to include 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.

The new rules would also provide that a transaction or series of transactions will be considered to include conditions that differ from arm's length conditions where:

• a condition does not exist as an actual condition, but would have existed had the participants to the in-scope transaction or series been dealing at arm's length in comparable circumstances; or
• the participants would not have entered into the transaction or series, or would have entered into a different transaction or series, had they been dealing at arm's length in comparable circumstances.

According to Budget 2025, the economically relevant characteristics of a transaction or series would be defined to include five comparability factors: contractual terms, functional profile, characteristics of the property or service, economic and market context, and business strategies. The functional profile includes the functions the parties performed for the wider multinational group, taking into account the assets used, risks assumed, value generated and industry practice.

Adoption of the OECD Transfer Pricing Guidelines

Budget 2025 explicitly adopts the OECD’s Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations. The proposed legislative text refers to the version of the guidelines adopted by the OECD Committee on Fiscal Affairs on January 7, 2022 and contemplates that other materials could be prescribed in the future. This is the first time Parliament has explicitly referred to the Guidelines in the legislation.

Changes to contemporaneous documentation

The original transfer pricing rule generally imposed a transfer pricing penalty equal to 10% of any transfer pricing adjustment exceeding $5 million unless the taxpayer made reasonable efforts to determine and use arm’s length prices, documented its efforts contemporaneously and responded to any request for contemporaneous documentation within three months.

Budget 2025 proposes to increase the penalty threshold to $10 million, but would shorten the deadline to respond to requests for contemporaneous documentation to 30 days. This change in deadline has implications for exposure to transfer pricing penalties. Budget 2025 also amends the mandatory contents of contemporaneous documentation and proposes certain simplification measures to be prescribed later.

The proposed amendments to the transfer pricing regime would apply to taxation years beginning after Budget Day.

Business income tax measures

Immediate expensing for manufacturing and processing buildings

Budget 2025 proposes the temporary immediate expensing of the cost of eligible buildings used to manufacture or process goods for sale or lease (including the cost of eligible additions or alterations made to such buildings). This measure would provide for 100% capital cost allowance in the first taxation year that the eligible property is used for manufacturing or processing, provided that at least 90% of the building’s floor space is used to manufacture or process goods for sale or lease.

Property that has been used (or acquired for use) for any purpose before it is acquired by the taxpayer would be eligible only if (i) neither the taxpayer nor a non-arm’s length person previously owned the property; and (ii) the property has not been transferred to the taxpayer on a tax-deferred “rollover” basis.

Recapture rules may apply where a taxpayer benefits from the immediate expensing of a manufacturing or processing building, and the use of the building is subsequently changed.

This measure is available for eligible property that is acquired on or after Budget Day and first used for manufacturing or processing before 2030. The rate increase will be gradually phased out after 2030, with the rate returning to 10% after 2033.

SR&ED tax incentive program

The Scientific Research & Experimental Development (SR&ED) tax incentive program provides for two tax incentives for qualifying SR&ED expenditures. First, qualifying SR&ED expenditures can be fully deducted in the year they are incurred. Second, such expenditures generally qualify for one of two investment tax credits (ITCs):

1. for Canadian-controlled private corporations (CCPCs), a fully refundable ITC of 35% of up to $3 million of qualifying SR&ED expenditures annually (35% ITC); or
2. for other corporations (or for qualifying SR&ED expenditures incurred by CCPCs that do not qualify for the 35% ITC), a non-refundable ITC of 15% of qualifying SR&ED expenditures annually.

For the 35% ITC, the $3 million annual expenditure limit is shared within an associated group and is gradually phased out where the CCPC’s taxable capital employed in Canada for the previous taxation year is between $10 million and $50 million.

Budget 2025 confirms the government’s intention to implement the following changes to the SR&ED program that were proposed in the 2024 Fall Economic Statement:

• increase the annual expenditure limit for the 35% ITC from $3 million to $4.5 million;
• increase the lower and upper prior-year taxable capital phase-out boundaries for the 35% ITC to $15 million and $75 million, respectively;
• extend eligibility for the 35% ITC to eligible Canadian public corporations; and
• restore the eligibility of SR&ED capital expenditures for both the deduction against income and investment tax credit components of the SR&ED program.

Budget 2025 proposes to further increase the annual expenditure limit for the 35% ITC to $6 million. This measure would apply for taxation years that begin on or after December 16, 2024.

Budget 2025 also introduces changes to improve predictability and streamline the administration of the SR&ED program, including:

• introducing an elective pre-claim approval process to provide businesses with up-front technical approval of eligible SR&ED projects, where the processing time for claims submitted through this process that require expenditure review will be reduced from 180 days to 90 days;
• increasing the use of artificial intelligence in the administration of SR&ED claims to avoid subjecting low-risk claims to unnecessary audit intervention; and
• speeding up the review process by eliminating unnecessary steps and reducing burdensome information requirements.

These changes will be implemented as of April 1, 2026. The Canada Revenue Agency (CRA) intends to engage in consultations to further improve the administration of the SR&ED program, which includes a review of the SR&ED claim form.

Mineral exploration tax credits and Canadian exploration expenses

Extension of the Mineral Exploration Tax Credit

The Mineral Exploration Tax Credit (METC) provides a 15% non-refundable tax credit on eligible mineral exploration expenses that are renounced to investors under qualifying flow-through share agreements. Budget 2025 confirms the government’s intention to extend the METC through to March 31, 2027.

Expansion of the Critical Mineral Exploration Tax Credit

The Critical Mineral Exploration Tax Credit (CMETC) provides an additional income tax benefit for individuals who invest in eligible flow-through shares equal to 30% of specified mineral exploration expenses incurred in Canada and renounced to flow-through share investors.

Budget 2025 proposes to expand the list of critical minerals eligible for the CMETC to include 12 additional critical minerals. This measure would apply to expenditures renounced under eligible flow-through share agreements entered into after Budget Day and on or before March 31, 2027.

Changes to the definition of CEE

The definition of Canadian exploration expenses (CEE) in the Tax Act includes certain expenses incurred by a taxpayer for the purpose of determining the existence, location, extent or quality of a mineral resource in Canada.

The British Columbia Supreme Court recently held that expenses incurred for technical studies focusing on a mineral resource’s engineering feasibility and economic viability were captured by the provincial equivalent of the federal definition of CEE. This ruling is contrary to the CRA’s long-standing position that such expenses are not CEEs. To avoid any uncertainty, Budget 2025 proposes to amend the Tax Act to clarify that expenses incurred for the purpose of determining the quality of a mineral resource in Canada do not include expenses related to determining the economic viability or engineering feasibility of the mineral resource. This proposed amendment would apply as of Budget Date.

Clean technology and green energy measures

Below is a brief overview of certain clean technology and green energy ITC measures included in Budget 2025.

Clean Electricity ITC

Budget 2025 confirms the government’s intention to implement the Clean Electricity ITC (CE ITC) and enhance other clean economy ITCs, indicating that it will soon introduce legislation on the CE ITC and enhancements to other clean economy ITCs that have already been enacted.

Clean Technology Manufacturing ITC

Budget 2025 proposes to expand the list of critical minerals eligible for the Clean Technology Manufacturing ITC to include five additional critical minerals. These measures would apply in respect of eligible property that is acquired and becomes available for use on or after Budget Day.

Carbon Capture, Utilization and Storage ITC

Budget 2025 proposes to extend the full carbon capture, utilization and storage ITC (CCUS ITC) rates for eligible expenditures to the end of 2035. Eligible expenditures incurred between 2036 and 2040 would be subject to a lower CCUS ITC rate. Budget 2025 also states that the government intends to postpone its review of the CCUS ITC rates, which will now occur before 2035.

Clean Electricity ITC and Canada Growth Fund

As previously detailed in draft legislation, the CE ITC may be claimed by a “qualifying entity” in respect of the capital cost of “clean electricity property” for projects that commenced construction on or after March 28, 2023.

Budget 2025 confirms the government’s intention to proceed with the CE ITC and proposes to eliminate the previously announced eligibility conditions on provincial and territorial Crown corporations seeking to claim the CE ITC. This change will allow provincial and territorial Crown corporations to claim the CE ITC without needing their jurisdiction to be designated based on net-zero commitments or ratepayer benefit undertakings, reducing administrative burden.

Under the proposed CE ITC rules, the capital cost of clean electricity property will be reduced by any “government assistance” or “non-government assistance” received or reasonably expected to be received, as defined in the Tax Act.

There has historically been a concern that loans from the Canada Infrastructure Bank (CIB) may be treated as government assistance for purposes of calculating the CE ITC, which would reduce the capital cost of eligible clean electricity property—and accordingly, the amount of the CE ITC. In 2024, the definition of “government assistance” was amended to exclude certain non-forgivable loans from a government, municipality or other public authority in Canada. It is expected that CIB financing will not be considered “government assistance”, and therefore not impact a taxpayer’s CE ITC.

Budget 2025 proposes to include the Canadian Growth Fund (CGF) as a qualifying entity and specifies that financing provided by CGF will not reduce the capital cost of clean electricity property. This proposal suggests CGF financing will be excluded from the definition of government assistance.

These measures in respect of the CE ITC would apply to eligible property that is acquired and that becomes available for use on or after Budget Day.

Consultations on domestic content requirement for the Clean Technology ITC and Clean Electricity ITC

Budget 2025 announces consultations on introducing a domestic content requirement for the Clean Technology ITC (CT ITC) and CE ITC. In general, domestic content requirements mandate that a certain percentage of components or materials must be sourced from a particular jurisdiction.

Tax deferral through tiered corporate structures

The Part IV tax regime is designed to prevent taxpayers from deferring income tax by holding investments and earning dividend income within a private corporation. In general terms, the Part IV tax regime accomplishes this by imposing a tax on certain dividends earned by private corporations that is roughly equivalent to the highest marginal personal income tax rate. Such tax is recoverable on the payment of a taxable dividend by the private corporation.

In particular, a private corporation is entitled to a dividend refund when it pays a taxable dividend and has a non-eligible refundable dividend tax on hand (NERDTOH) balance or an eligible refundable dividend tax on hand (ERDTOH) balance. If the dividend recipient is a private corporation “connected” with the dividend payer corporation for these purposes, the dividend recipient corporation will be subject to Part IV tax in an amount based on the dividend payer corporation’s dividend refund. The dividend recipient also adds a corresponding amount to its NERDTOH or ERDTOH balances. For these purposes, the recipient corporation is generally considered to be connected with the payer corporation if the recipient corporation controls the payer corporation or owns more than 10% of the votes and value of the payer corporation.

The timing of the dividend refund and Part IV tax liability presents a deferral opportunity where staggered corporate year ends are used within a corporate chain. For example, assume Corporation A has a tax year ending December 1, 2025 and Corporation B has a tax year ending November 1, 2025. If Corporation A pays a taxable dividend to Corporation B on November 30, 2025 (i.e., after Corporation-B’s year-end), Corporation A would receive a dividend refund for its December 2025 year-end and Corporation B could defer remitting Part IV tax (for up to approximately 11 months) or avoid remitting Part IV tax altogether by paying an equivalent taxable dividend before November 1, 2026. This deferral of Part IV tax could continue if the year-end of a corporate dividend recipient shareholder of Corporation B was similarly staggered.

Budget 2025 proposes to introduce new rules to restrict this form of deferral planning. The proposed rules will deem a dividend paid by a corporation not to be a taxable dividend for the purpose of calculating the payer corporation’s dividend tax refund when certain conditions are met. Where the new rule applies to deem the dividend not to be a taxable dividend, the payer corporation will not receive a dividend refund. The recipient corporation would correspondingly not be subject to Part IV tax in respect of the dividend.

A dividend refund that is suspended by the application of the new rule can be released where certain conditions are met.

Exceptions

Budget 2025 proposes certain exceptions to these new rules. First, the proposed rule would not apply if each corporate dividend recipient in the chain of affiliated corporations pays a subsequent dividend on or before the dividend payer’s balance-due day, such that no deferral is achieved by the affiliated corporate group. Second, to accommodate standard bona fide commercial transactions, the proposed rule would not apply to a dividend payer that is subject to a “loss restriction event” (for example, an acquisition of control) within 30 days of the date that it paid the dividend.

This measure would apply to taxation years that begin on or after Budget Day.

Anti-avoidance rule

Budget 2025 also proposes to broaden an anti-avoidance rule that denies a dividend refund where a share of a corporation is acquired in a transaction or as part of a series of transactions one of the main purposes of which is to enable the corporation to obtain a dividend refund. The proposed amendments will expand this rule to apply where one of the main purposes of a transaction or series is to enable another corporation affiliated with the issuer corporation to obtain a dividend refund.

This measure would apply to taxation years that begin on or after Budget Day.

Personal income tax measures

Qualified investments for registered plans

Following consultations announced in Budget 2024, Budget 2025 proposes changes to the investments that registered plans³ can hold (Qualified Investments).

Under current rules, units of certain trusts that are not Qualified Investments, such as mutual funds that have not met the 150 unit-holder condition or certain pooled fund trusts, can register and become qualified investments (Registered Investments). Trusts that are Registered Investments may only hold Qualified Investments; otherwise, they will be subject to a penalty tax. As part of the Budget 2024 consultation process, stakeholders requested changes to the current Registered Investment rules to expand the types of investments which may be held by Registered Investments.

Budget 2025 proposes to repeal the current Registered Investments regime effective January 1, 2027 and replace it with two new categories of Qualified Investments (available as of Budget Day):

• units of a trust governed by National Instrument 81–102, which regulates certain mutual funds and non-redeemable investment funds; and
• units of a trust that is an “investment fund” (as defined in the Tax Act) whose managers are registered under National Instrument 31–103.

The new categories are generally subject to concentration limits but are expected to facilitate better access to pooled fund investments for registered plans. There has been increasing demand by registered plan investors to be able to participate in other types of investments, such as private credit. These types of investments lack immediate liquidity but may be suitable for individuals with retirement or long-term saving goals.

The new categories generally will not permit investments in real property or control positions in companies or businesses. The new categories of Qualified Investments do not explicitly require that trusts meet the “unit trust” “redeemable on demand” condition.

The new categories do not completely overlap with the current Registered Investments regime. For example, under the current rules, one category of registered plan allowed a trust to hold some real property. The two new categories generally would not permit any real property to be held. In addition, for funds that are registered under existing rules and which seek to rely on the new rules immediately, there is no transition rule to “turn off” their existing Registered Investment status. We understand that the Department of Finance is open to receiving submissions on these and other issues.

As part of Budget 2025, the government will also consolidate the Qualified Investment definitions for six registered plans into a single provision in the Tax Act (excluding deferred profit-sharing plans) and reorganize the prescribed investment list by asset class (e.g., debt or equity) to enhance usability.

21-year deemed disposition for trusts

Generally, a trust is deemed to dispose of its capital property every 21 years for purposes of the Tax Act. This deemed disposition rule can trigger tax where the trust property has accrued gains. Where a taxable disposition of the property is not desirable, trusts can take advantage of certain rules in the Tax Act that permit, in qualifying circumstances, the trust property to be transferred on a tax-deferred basis (commonly referred to as a “rollover”) to one or more beneficiaries that meet certain conditions.

However, where trust property is distributed to a beneficiary that is another trust on a tax-deferred basis, an anti-avoidance rule deems the beneficiary trust take on the 21-year date of the distributing trust for the purposes of the deemed disposition rules described above. Without this rule, the 21-year deemed disposition could be deferred indefinitely by continually rolling trust property from one trust to another.

The language of this anti-avoidance rule contemplates transfers from one trust “to another trust”, suggesting that it only refers to direct trust-to-trust transfers. Indirect transfers, where, for example, property is rolled out of a trust to a beneficiary that is a corporation with a trust as its shareholder, are not contemplated by this anti-avoidance rule. The CRA has previously stated it would apply the general anti-avoidance rule (GAAR) to such indirect trust-to-trust transfers via a controlled corporation, and such transfers are also a notifiable transaction for the purposes of the Tax Act.

Budget 2025 proposes to broaden the scope of this anti-avoidance rule. The amended rule would apply when property is transferred "directly or indirectly in any manner whatever" from one trust to another, in circumstances where specific roll-out provisions in the Tax Act are used or where the transfer is not considered a taxable disposition by the trust by virtue of certain tax rules. Accordingly, it is anticipated that this amendment would capture transactions using a controlled corporation as described in the example above.

This amendment would apply in respect of transfers of property that occur on or after Budget Day.

Sales and excise tax measures

Budget 2025 introduces the following proposals in respect of sales and excise tax:

• repealing the underused housing tax effective January 1, 2025;
• eliminating the luxury tax on subject aircraft and vessels effective after Budget Day;
• consultations on GST/HST amendments to combat carousel fraud schemes; and
• amendments to clarify the longstanding policy that osteopathic services rendered by individuals who are not osteopathic physicians are subject to GST/HST.

To combat carousel fraud schemes where GST/HST is collected but not remitted to the government, Budget 2025 proposes a new reverse charge mechanism (RCM) that will initially apply only to specified telecommunications services. Under this regime, recipients of specified telecommunications will be required to self-assess the applicable GST/HST and where eligible, claim an input tax credit to offset against their remittance obligations. Suppliers of these services will be required to indicate on their invoices that the RCM applies so recipients know to account for the GST/HST through self-assessment. Budget 2025 leaves open the possibility that other supplies may be subject to these new rules through regulation in the future.

The government has invited interested parties to share their feedback on these proposals by January 12, 2026.