(Article originally appeared in Ernst & Young's East Coast Offshore quarterly newsletter. To view, visit ey.com/ca/oilandgas)
Spring is upon us and our thoughts turn toward spring flowers, warm evening walks, barbecues and doing taxes. With their complex business structures, many oil and gas companies view this annual tax-filing process simply as a requirement imposed on them by the government — a time for more stress and hard work. But can it be more? We believe tax season gives you an opportunity to take a closer, more detailed look at your business. It's a chance to take a fresh perspective on your past strategies and to ask some tough questions about your future goals. Such scrutiny and careful planning are especially crucial today as the economy grows stronger and more competitive in the recovery. It is a new era — with a new performance agenda and a more globalized platform in which to compete.
Now is the time for Canada's East Coast oil and gas companies to look at their current corporate structures to determine whether they are as tax effective as they were once intended to be. With today's changing business model, it's important to understand whether your company's Canadian domestic operations are exposed to the taxing authorities of foreign jurisdictions. And depending on the stage of your business plans, succession planning may be a priority.
There's no better time than tax season to address and analyze these issues. It's an ideal chance to legally reorganize your business to maximize tax benefits or to better match legal structure with current operations. Capitalizing on our Tax team's experience advising oil and gas companies across Atlantic Canada and around the world, we've outlined some areas for you to consider when gathering information for your tax returns.
Adapting corporate structure in changing times
Many corporate groups were established with a specific business model in mind, but over the years, most successful businesses have adjusted their original intentions in order to grow, or even survive. One example is when a corporate structure has evolved to such a level that losses are essentially being "trapped" in one entity while another related corporate entity is generating profits and paying cash tax. This can occur when an original corporation is holding the corporate debt, but the operations are contained in subsidiaries that were capitalized with equity.
Since Canada doesn't have a consolidated tax filing system for related corporations, in order to use your corporation's losses to shelter another's income, you may need to structure transactions to generate income in one entity and losses in another within the same corporate group. Over the years, many oil and gas companies have used this strategy in Canada. However, the Canada Revenue Agency (CRA) has taken an increasingly investigative look into these inter-corporate transactions to see if they satisfy a bona fide business purpose.
Generally, you can restructure your corporation to realign your profitable operations with the third-party interest charge without raising the ire of the Canadian taxing authorities. This creates an opportune time to embed your succession plan into your corporate restructuring. Finally, it's important to note that the CRA is undertaking a comprehensive study with solicited feedback from tax service providers to establish whether the Canadian tax system could be adapted to include a tax consolidation feature similar to that of most sophisticated tax regimes around the world.
Taking a close look at cross‑border activity
If your corporation is doing business across borders, there is the ever-present risk that your entity could be deemed to have a permanent establishment in the foreign country, thereby exposing your Canadian company to taxes on income earned in that jurisdiction. Proper corporate structuring will help insulate your corporation from unexpected foreign tax consequences.
The issues involving transfer pricing (when one corporation is transacting with a related party in another country) are well beyond the scope of this article. But the general premise is that related-party cross-border charges should be similar in quantum to those that would be charged to an unrelated arm's-length party. This is to ensure each country's taxing authority is getting its fair share of the pie. As all tax authorities are looking at this area of tax with higher scrutiny, it's very important to have your contemporaneous documentation ready, and to ensure you've solicited the right advice on navigating this complex process.
The year-end corporate tax compliance process provides you with a great opportunity to review your crossborder activities to ensure all required documentation is in place and in sufficient format to satisfy the watchful eye of Canadian and non-resident transfer-pricing authorities. It's also the time to review payments made to non-residents and ensure that the necessary withholding taxes have been remitted. As many have learned, this is an area of close scrutiny by the CRA that can yield costly lessons in the form of failure-to-withhold and remit penalties and related interest.
Lessons learned from tax season
The year-end corporate tax compliance process does not have to only be about preparing a corporate tax return and paying taxes. Instead, it should be a time for business owners to sit back and reflect on where their company has been, where it is now and where it is going. Once you've determined this, you can take steps to make any required changes to your corporate structure that will better allow your business to grow while still maintaining a tax-compliant (and efficient) enterprise. And finally, once this is complete, it will leave more time for you to enjoy the barbecue season!
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.