Summer 2026 Canadian draft tax legislation release: simplified transfer pricing documentation regime, hybrid mismatch rules and more Summer 2026 Canadian draft tax legislation release: simplified transfer pricing documentation regime, hybrid mismatch rules and more

On July 23, 2026, the Canadian federal government released draft legislation to implement various tax measures, update certain previously released draft legislation and make certain technical changes (July 2026 proposals).

The key measures included in the July 2026 proposals are simplified transfer pricing documentation requirements, first proposed in Budget 2025, and amendments to the second package of hybrid mismatch rules released in January 2026. The July 2026 proposals also amend the foreign accrual property income (FAPI) services rule for investment funds in subparagraph 95(2)(b)(i) previously recommended in a comfort letter from the Department of Finance.

The news release that accompanied the July 2026 proposals invites Canadians to make submissions on the measures by September 4, 2026. This deadline for comments allows time for amended tax legislation to be introduced in Parliament during the fall sitting. Parliament resumes from its summer break on September 21, 2026.

Transfer pricing: simplified documentation requirements

Canada’s new transfer pricing rules, enacted on March 26, 2026, apply to taxation years beginning after November 4, 2025. They contemplate that simplified documentation requirements could be prescribed by regulation. The July 2026 proposals include the first details and draft regulations for this simplified regime.

Under the transfer pricing rules, taxpayers are subject to a 10% penalty on any transfer pricing adjustment greater than $10 million unless they made reasonable efforts to use arm’s length pricing for the adjusted transaction(s) or series. The “reasonable efforts” defence is not available if the taxpayer did not timely prepare contemporaneous documentation meeting the requirements in subsection 247(4) and provide it to the CRA within 30 days of a request.

The new simplified documentation requirements are intended to reduce the compliance burden and provide penalty protection for a limited set of qualifying transactions. The July 2026 proposals contemplate such simplified documentation in four circumstances:

1. Small taxpayers and partnerships meeting three conditions:
   • gross revenue of the taxpayer or partnership plus any other member of the multinational enterprise group that is resident in Canada is $25 million or less during the prior taxation year or fiscal period
   • no dispositions of intangible property during the taxation year or fiscal period to a non-arm’s length non-resident
   • no royalty payments between the taxpayer or partnership and a non-arm’s length non-resident during the taxation year or fiscal period
2. Dispositions of tangible property to or from a non-arm’s length non-resident where the gross amount paid or payable for the property during the taxation year or fiscal period is $5 million or less
3. Intra-group services provided to or from a non-arm’s length non-resident where the gross amount paid or payable for the services during the taxation year or fiscal period is $2 million or less
4. Loans made to or from a non-arm’s length non-resident where the gross amount of interest paid or payable on the loan during the taxation year or fiscal period is $1 million or less

Where one of these circumstances applies, a taxpayer or partnership may elect to use the simplified documentation requirements for the relevant transaction or series (or, for small taxpayers and partnerships, for all transactions or series that year). The election must be filed by the documentation due date for the taxation year or fiscal period.

Taxpayers and partnerships electing into the simplified regime need to prepare only the following information by their documentation-due date (the filing-due date for the taxpayer’s tax return for the year):

1. In all cases:
   • the terms and conditions of the transaction or series, including
     • the identity of the participants
     • the relevant property, services or details of the loan (the principal amount, term, issuance date, maturity, credit rating of the borrower, interest rate, currency and payment terms)
     • the amounts paid or payable
   • the analysis undertaken to determine the amounts are based on arm’s length conditions
2. For small taxpayers and partnerships only: calculation of the gross revenue of the taxpayer or partnership plus any other member of the multinational enterprise group that is resident in Canada during the prior taxation year or fiscal period
3. For loans only: the purpose of the loan

Where the transaction or series continues into subsequent taxation years or fiscal periods, taxpayers and partnerships only need to document material changes to this information.

The simplified documentation strips the analysis down to the core elements supporting the taxpayer’s pricing. By contrast, the regular contemporaneous documentation rules — particularly following the recent amendments — require describing relevant group-wide transactions, discussing realistic alternatives available to the parties and why the controlled transaction makes commercial sense compared to those alternatives, and explaining why the selected methodology is the most appropriate under the OECD Guidelines. Although the simplified documentation regime expressly exempts qualifying taxpayers and transactions from those more onerous requirements, it is not clear that this represents a diminished compliance burden as compared to past practice. Taxpayers and their advisors have historically taken a more practical approach to simple, low-value transactions. The CRA has long endorsed more stripped-down documentation for such transactions in its published guidance, observing that “[w]hen preparing documentation the taxpayer should attempt to weigh the significance of the transactions in relation to their business with the additional administrative costs required” and, accordingly, “[t]axpayers are not required to go beyond what is reasonable in terms of documentation.”

The simplified documentation must be provided to the Minister within 30 days of any request to do so, the same shortened deadline applicable under the amended rules for larger and more complex transactions.

An anti-avoidance rule deems a taxpayer or partnership not to qualify for the simplified documentation regime if it is reasonable to conclude that one of the purposes of the transaction or series was to benefit from the simplified documentation regime. The explanatory notes that accompanied the July 2026 proposals provide two examples in which the anti-avoidance rule would apply. The first is a taxpayer that would not qualify as a small taxpayer because it makes royalty payments to a non-arm’s length non-resident, who creates a new entity capable of qualifying and assigns contracts to it. The second example describes transactions that are split up for the purpose of staying within the monetary thresholds for dispositions of tangible property, intra-group services and interest on loans.

The simplified documentation regime is available for taxation years and fiscal periods that begin on or after January 1, 2026.

While the new rules are presented as providing relief to all taxpayers and partnerships for eligible small transactions, as well as to eligible small taxpayers and partnerships for all their transactions, the practical impact may be more limited. The simplified documentation requirements are intended to reduce the cost of complying with Canada’s transfer pricing documentation rules for purposes of avoiding the transfer pricing penalty. However, the simplified documentation largely reflects what taxpayers would ordinarily have prepared for such low-value transactions under the prior regime and administrative practice. In addition, given the dollar thresholds for tangible property, services and loans, penalty exposure (which is irrelevant where adjustments do not meet the $10-million threshold) would be reduced only in limited circumstances, such as where CRA makes larger adjustments on other transactions (to which the regular documentation rules apply) in the same taxation year.

Amendments to second package of hybrid mismatch rules

Canada’s hybrid mismatch rules implementing the OECD’s BEPS Action 2 Report recommendations have been introduced in two legislative packages.

1. The first package (the 2022 hybrid mismatch rules), enacted on June 20, 2024, with retroactive application to payments arising on or after July 1, 2022, targeted deduction/non-inclusion (D/NI) mismatches arising from payments under hybrid financial instruments, where the mismatch is attributable to the terms of the instrument rather than the hybridity of an entity.
2. The second package (the 2026 hybrid mismatch rules) was released in draft on January 29, 2026, and addresses mismatches arising from the hybridity of an entity (reverse hybrids, disregarded payments and hybrid payers) as well as imported mismatches. The measures in the second package were proposed to apply to payments arising on or after July 1, 2026.

The July 2026 proposals update the 2026 hybrid mismatch rules and the accompanying explanatory notes, including certain amendments identified by the Joint Committee on Taxation of the Canadian Bar Association and Chartered Professional Accountants of Canada (Joint Committee).

Key changes to the draft legislation

1. New thin capitalization ordering rule: Subsection 18(4) (the thin capitalization rule) is amended to apply in priority to the hybrid mismatch rules for payments arising on or after July 23, 2026. This ordering rule was suggested by the Joint Committee in response to concerns raised by the Department of Finance that if the hybrid mismatch rules applied first, taxpayers may structure transactions to fall within those rules in order to avoid withholding tax on the deemed dividend applicable to interest denied under the thin capitalization rules. There are consequential amendments to the draft 2026 hybrid mismatch rules to ensure the thin capitalization rules apply in priority to the hybrid mismatch rules.
2. Changes to the deemed dividend rule: The 2022 hybrid mismatch rules introduced subsection 214(18), which deems interest paid by a Canadian corporation to a non‑resident to be a dividend for Part XIII purposes, but only to the extent that the interest is denied as a deduction under the primary rule in subsection 18.4(4). The draft legislation for the second package introduced on January 29, 2026, proposed to extend the deemed dividend treatment to the new categories of hybrid mismatches and to situations where income is included under the secondary rule in subsection 12.7(4). The July 2026 proposals explicitly carve out the new categories from the deemed dividend rule and remove the reference to the secondary rule. As a result, only interest denied under the primary rule in respect of the categories from the 2022 hybrid mismatch rules will result in a deemed dividend for Part XIII purposes. The explanatory notes state that the reason for the carve-out is that the new categories of hybrid mismatches introduced in the second package are “not inherently equity substitutes.” This amendment would apply as of July 1, 2026, effectively neutralizing the extended deemed dividend treatment originally introduced in the second package of amendments.
3. New valuation rule for hybrid payer mismatches: The hybrid payer mismatch rule prevents double deductions (DD) for the same payment due to the involvement of a hybrid payer. The January 2026 version of proposed subsection 18.4(7.2) measured the DD mismatch as the amount that would otherwise be deductible in Canada. The July 2026 proposals amend subsection 18.4(7.2) so that the amount of the DD mismatch is the lesser of (1) the amount that would otherwise be deductible in Canada and (2) the amount that would be deductible in a foreign jurisdiction absent a foreign rule denying the deduction. New subsection 18.4(7.3) addresses valuation differences: where those two amounts differ due to valuation, the foreign deduction must be determined using the same valuation as the Canadian deduction.
4. Conditions for reverse hybrid arrangement in subsection 18.4(15.1): The reverse hybrid arrangement rule applies to payments made to reverse hybrids (defined as an entity treated as a separate entity (opaque) by its investors but fiscally transparent in the jurisdiction where it is established). The January 2026 draft legislation applied where the payer and the reverse hybrid entity are non-arm’s length or the payment is made under a structured arrangement. The July 2026 proposals expand this relationship test to also include a reference to an equity holder of the reverse hybrid entity that is resident in a country that views the reverse hybrid entity as fiscally opaque in respect of the payment.
5. Ordinary income deeming rules in subsections (16.1) to (16.4): The January 2026 draft legislation included a definition of “ordinary income” — generally meaning the amount included in computing an entity’s taxable income in respect of any country that is subject to tax — for purposes of determining if an entity has dual inclusion income (which, generally, reduces the amount of a hybrid mismatch). In response to recommendations made by the Joint Committee, new subsections 18.4(16.1) and 18.4(16.2) deem two types of amounts to be ordinary income of an investor in a hybrid entity:
   • Subsection 18.4(16.1) applies where the investor (in a hybrid entity) pays an amount to the hybrid entity that is ordinary income of the hybrid entity and that would have been deductible by the investor if the payment were not disregarded under the tax laws of the investor country, and no amount in respect of the payment was deductible by any entity in any jurisdiction.
   • Subsection 18.4(16.2) applies where one hybrid entity makes a payment to another hybrid entity in the same country. That payment will be ordinary income of an entity that is an investor in both hybrid entities where
     • the investor is in a different country
     • the payment is disregarded by the investor’s country but not the hybrid entities’ country
     • the payment is ordinary income of the recipient hybrid entity
     • the payment is not ordinary income of the investor in respect of any country but would have been ordinary income in respect of the investor’s country if it had not been disregarded
     • the payment would have been ordinary income of the payer hybrid entity absent the application of new subsection 18.4(16.4) (as discussed below)

New subsections 18.4(16.3) and 18.4(16.4) prevent the same amount from being treated as ordinary income more than once. These provisions apply where an amount is deemed to be ordinary income of an investor under subsection 18.4(6.2), and that deemed ordinary income reduces a hybrid mismatch amount (or investor hybrid payer mismatch amount, or impacts the amount of a paragraph 20(1)(zz) or (aaa) deduction) because it impacts the computation of any entity’s dual inclusion income (or investor dual inclusion income). In such circumstances, the amount is deemed not to be ordinary income of the payer hybrid to the extent that it has already given rise to deemed ordinary income under subsection 18.4(6.2).

Key changes to the explanatory notes

1. Definition of “foreign hybrid payer mismatch rule”: The hybrid payer arrangement rule applies to payments by a Canadian-resident hybrid entity that give rise to a DD mismatch, but only to the extent that a foreign hybrid payer mismatch rule does not neutralize the mismatch. A “foreign hybrid payer mismatch rule” is defined as a rule enacted with the intention of implementing the relevant chapters in the BEPS Action 2 Report that has a substantially similar effect. The Joint Committee asked the Department of Finance to confirm that the U.S. dual consolidated loss (DCL) rules would qualify. The July 2026 explanatory notes clarify two points: first, a foreign tax law may qualify as a “foreign hybrid mismatch rule” even if it was enacted before the OECD BEPS Action 2 Report; and second, the rule only needs to produce a “substantially similar” effect and does not need to be identical to the OECD framework. These changes are particularly relevant for the U.S. DCL rules, as some jurisdictions, such as the U.K., have taken a narrower approach that requires a foreign hybrid mismatch rule be “based on” the OECD BEPS Action 2 Report — a threshold the U.S. DCL rules do not meet because they pre-date BEPS.
2. Meaning of “resident” in subsection 18.4(19.2): Several concepts in the 2026 hybrid mismatch rules depend on whether an entity is “resident” in a country. The January 2026 draft legislation defined “resident” as meaning resident in a country for income tax purposes under the laws of that country. The July 2026 explanatory notes clarify two points: first, an entity is considered resident in a country if, under that country’s income tax law, it is subject to comprehensive taxation there (meaning it is treated as tax resident for domestic law purposes based on factors such as incorporation, management, domicile or citizenship); and second, if a tax treaty tie-breaker clause results in the entity not being treated as resident in a country, that entity is not resident in that country for purposes of the hybrid mismatch rules.
3. Definition of “ordinary income”: The July 2026 explanatory notes include examples clarifying the definition of “ordinary income” and what it means to be effectively sheltered from income or profits tax by offsetting relief. The examples describe relief applied both in computing net income (e.g., deductions) and after net income is determined (e.g., credits), and in each case relate to relief tied to a specific income amount.
4. Definition of “hybrid entity”: The July 2026 explanatory notes clarify that inclusion in a controlled foreign affiliate regime such as FAPI is not sufficient for an entity to be considered a hybrid entity. A hybrid entity is defined as an entity that is resident in one country, but where another country treats some or all of its income, profits, expenses or losses as belonging to a different entity that is resident in that other country (i.e., the other country treats the entity as a disregarded entity or a branch).

While the July 2026 proposals deal with some of the issues raised by the Joint Committee, others remain unaddressed. These include the Joint Committee’s recommendation to delay the effective date of the 2026 hybrid mismatch rules to provide taxpayers with additional time to assess and implement the complex new requirements. However, some of the changes in the July 2026 proposals only apply from the announcement date.

FAPI treatment for provision of services to investment funds

The package of technical amendments includes a relieving amendment to subparagraph 95(2)(b)(i) that was originally proposed in a Department of Finance comfort letter in 2017. The amendment is intended to address an anomalous result that may otherwise arise where a foreign affiliate (ManagerCo) of a Canadian corporation (CanCo) provides investment management services to an investment fund (InvestCo). Where InvestCo is not a foreign affiliate of CanCo (generally where CanCo and related persons own less than 10% of InvestCo), then any fees paid by InvestCo to ManagerCo will generally be included in computing the active business income of ManagerCo. However, if InvestCo is a foreign affiliate of CanCo (including as a result of CanCo providing seed capital or otherwise owning a separate class of shares of InvestCo), then current subparagraph 95(2)(b)(i) generally deems all income earned by ManagerCo to be FAPI.

The proposed amendment would generally limit the FAPI treatment of ManagerCo’s income to CanCo’s proportionate ownership in the investment fund. For example, if ManagerCo earns $100 in respect of the investment fund and CanCo owns 1% of the fund, $1 of ManagerCo’s earnings will be FAPI while the remaining $99 will be active business income.

A prior version of the proposed amendment was released in August 2022. The July 2026 version of the amendment introduces additional details and requirements for determining what proportion of income earned by the investment manager is FAPI, including rules specific to partnerships.

The new rule is applicable to taxation years of a foreign affiliate of a taxpayer that begin after 2015.

Other measures included

The July 2026 proposals include draft legislation for the following other items:

• accelerated capital cost allowance for low-carbon LNG facilities (proposed in Budget 2025, with additional details provided in the 2026 Spring Economic Update)
• extension of the carbon capture, utilization and storage tax credit to enhanced oil recovery projects (proposed in the 2026 Spring Economic Update)
• amendments to the Excise Tax Act to address carousel schemes (proposed in Budget 2025)
• an amendment to subparagraph 95(2)(a.2)(i) relating to the FAPI treatment for investments in Canadian insurance risk (proposed in Budget 2025)

If you have any questions or require additional analysis on the July 2026 proposals, other measures discussed above or any other Canadian tax matter, please contact any member of our National Tax Department.