Canada: Canada Moves To Enact Backlog Of Proposed Income Tax Amendments

On November 21, 2012, the NWMM was tabled in the House of Commons as Bill C-48, the Technical Tax Amendments Act, 2012 (Bill C-48). Bill C-48 covers most of the current backlog of draft amendments to the ITA which have previously been released for public consultation. Many of the previously announced amendments are included in the Bill C-48 without modification. In some cases, there are minor technical corrections. In some areas, the changes are more significant.

The changes in the NWMM affecting the foreign affiliate provisions are discussed in a separate recent edition of our Blakes Bulletin on Tax. Certain other changes which may be of interest to our clients are discussed below.

Non-Resident Trusts

Under the non-resident trust (NRT) proposals in section 94 of the ITA, an NRT could be deemed to be resident in Canada and subject to Canadian tax if there is a Canadian resident beneficiary or a Canadian resident contributor. There are exemptions in respect of certain types of NRTs, including foreign commercial trusts. The most recent version of the NRT proposals were released for public comment on August 27, 2010 (the August 2010 Proposals). See our October 2010 Blakes Bulletin on Tax: Foreign Commercial Trusts – The Latest Non-Resident Trust Proposals.

Bill C-48 proposes to expand the exemption in respect of foreign commercial trusts. The exemption applies where an NRT meets one of the following requirements:

  • there are at least 150 beneficiaries, each holding specified fixed interests (SFIs) in the trust with a total fair market value of at least C$500;
  • all SFIs in the trust are listed on a "designated stock exchange" (as defined in the ITA) and SFIs are traded on that exchange on at least 10 of every 30 days; or
  • each outstanding SFI was either (1) issued by the trust for least 90% of the proportionate share of the net asset value of the trust's property, or (2) acquired for fair market value consideration.

An SFI was defined in the August 2010 Proposals as an interest in the trust in respect of which "no amount of the income or capital of the trust to be distributed at any time in respect of any interest in the trust depends on the exercise by any person or partnership of, or the failure by any person or partnership to exercise, any discretionary power." Under Bill C-48, an SFI is now called a "fixed interest" and the definition of fixed interest now excludes a power in respect of which it is reasonable to conclude that:

  • the power is consistent with normal commercial practice;
  • the power is consistent with terms that would be acceptable to the beneficiaries under the trust if the beneficiaries were dealing with each other at arm's length; and
  • the exercise of, or failure to exercise, the power will not materially affect the value of an interest as a beneficiary under the trust relative to the value of other such interests in the trust.

The Explanatory Notes state that discretion in respect of the timing of distributions is not intended to be caught. This new exclusion would also appear to permit other kinds of administrative discretion given to the trustee or administrator of the trust – such as the discretion to allocate common expenses over multiple series of trust units on a reasonable basis.

The definition of "exempt person" is also proposed to be changed to include most Canadian mutual fund trusts and corporations. The effect of this change is to exempt the mutual fund itself from personal liability under the NRT rules, even if the fund invests in a non-exempt non-resident trust. According to the Explanatory Notes, the reason for this exemption is to relieve the significant compliance burden that might otherwise arise for Canadian mutual funds in determining whether each of their investments in a non-resident trust is exempt from the NRT provisions. The exemption for mutual funds does not apply to a mutual fund trust or corporation if:

  • the fund holds property that is, or derives its value from, an interest in a trust, and
  • statements or representations are made in respect of the fund by the fund (or by a promoter or other representative) in respect of the acquisition or offering of an interest in the fund that
    • the Canadian taxes on the income, profit or gains in any year in respect of the above property are less than, or are expected to be less than,
    • the Canadian tax that would have been applicable if the income, profits or gains from the property had been earned directly by the person who acquires an interest in the fund.

Section 94.2 of the August 2010 Proposals provided that, if a non-resident trust qualified for the exemption for foreign commercial trusts, and there is a Canadian resident beneficiary who (together with other specified persons) holds at least 10% of the fair market value of all SFIs in the trust, the trust is deemed to be a controlled foreign affiliate (CFA) of the Canadian resident beneficiary for the purposes of the foreign accrual property income (FAPI) provisions of the ITA. Under Bill C-48, section 94.2 is proposed to be expanded to cover not only a Canadian resident beneficiary of an exempt foreign commercial trust, but also mutual funds referred to above, CFAs of Canadian resident persons and partnerships of which any of such entities is a partner. The scope of the 10% threshold is also expanded to refer to 10% of the fair market value of the fixed interests of any class.

Another change in Bill C-48 is to include foreign commercial trusts under the "offshore investment fund" regime in existing section 94.1 of the ITA, even if the trust is also caught by the above FAPI provisions, although the provisions can be read in a manner such that there should be no double taxation and the Explanatory Notes to Bill C-48 suggest this is the intention.

Bill C-48 also proposes significant changes to the method of determining the "resident portion" of an NRT. Further, the resident portion and non-resident portion treatment is only available if the NRT elects to become an "electing trust". If no such election is made, the NRT would be taxed as a Canadian resident on all income and gains on all of its property. In general, these changes will be relevant only in respect of an NRT (other than an exempt foreign trust) which is subject to deemed residence in Canada because it has one or more Canadian resident beneficiaries or Canadian contributors.

The NRT proposals are generally applicable to taxation years of trusts that end after 2006, although taxpayers may elect to have the proposals apply to their taxation years that end after 2000 and before 2007.

Restrictive Covenants

Proposed amendments to the ITA to deal with "restrictive covenants" were first announced on October 7, 2003 and are included in draft legislation released for public comment on July 16, 2010 (the July 2010 Proposals).

In essence, these proposals require that, if a person receives an amount in respect of a broadly defined "restrictive covenant," the amount is included in the income of the recipient (or in some circumstances a person not dealing at arm's length with the recipient), unless certain limited exceptions apply in respect of the sale of shares or a business. Where the income inclusion is to a non-resident, the payer has an obligation to withhold Canadian withholding tax. The main rules are set out in proposed section 56.4 of the ITA. Proposed amendments to section 68 of the ITA also provide that the price of property or services could be reallocated to a payment for a restrictive covenant. In some cases, exemption from reallocation under section 68 is available, but only if the payer and the recipient made a joint income tax election.

Bill C-48 proposes substantial changes to the structure of section 56.4. One change is to provide an exemption from a reallocation under section 68 in respect of a restrictive covenant given to a related adult individual. It is also proposed that, if a restrictive covenant is given on or before October 24, 2012, the exemption from reallocation under section 68 is automatically available, without having to file an election.

Limitation on Deductible Expenditures made by Issuing Shares or Options

On November 17, 2005, the Minister of Finance announced a proposal to limit the deductibility or other recognition of expenditures that are paid by the issuance of options, shares or other interests in the taxpayer. This is set out in proposed section 143.3 of the ITA which was released as part of the July 2010 Proposals.

Under the July 2010 Proposals, proposed section 143.3 could apply where the fair market value of the share or other interest in the issuing taxpayer exceeded the fair market value of the property transferred to or services provided to the issuer. The July 2010 Proposals included a specific provision that clarified for greater certainty that the issuance of a share of a corporation is deemed to be a transfer of property. This addressed a technical concern that, without this clarification, there might not be a "transfer of property" where a corporation issues its shares to another person (because the corporation has not given up any of its property).

Bill C-48 proposes to delete the clarifying provision in respect of corporate shares and instead provide that the limitation under section 143.3 applies where the fair market value of a share or other interest in the issuing taxpayer exceeds the fair market value of the property transferred or issued to, or services provided to, the issuer. The addition of the words "or issued to" now makes it clear that the fair market value test applies to not only shares of a corporation, but also trust or partnership interests. This clarification is helpful where, for example, a trust issues units of itself to another person in exchange for an interest in or a promissory note of the other person.

Foreign Exchange Gains and Losses on Capital Account

Subsection 39(2) of the ITA currently provides that, if a taxpayer makes a gain or sustains a loss on capital account by virtue of the fluctuation of foreign currency, the net gain or loss is deemed to be a capital gain or loss from the disposition of foreign currency. One of the reasons why this provision is necessary is because capital gains and losses are taxable under the general rules only if there is a "disposition" of property. Thus, the general rule would not apply to a foreign exchange gain or loss on the payment of an obligation such as a loan payable.

On August 19, 2011, the Minister of Finance released proposed amendments to amend foreign affiliate provisions in the ITA. As part of these changes, it was also proposed to amend subsection 39(2) to apply only to foreign exchange gains or losses on "foreign currency debt" – defined as a debt obligation denominated in a non-Canadian currency. New subsection 39(1.1) of the ITA is also proposed to be added to apply to tax foreign exchange gains and losses from dispositions of foreign currency by an individual, but only where the net amount exceeds C$200 per year.

Under Bill C-48, amended subsection 39(2) will be more similar to the existing wording of that subsection. It will apply where a taxpayer has made a gain or sustained a loss on capital account because of the fluctuation of foreign currency, subject to new carve-outs for gains or losses:

  • that are subject to the general rule for capital gains or losses from the disposition of property;
  • that are covered by proposed subsection 39(1.1) discussed above; or
  • in respect of a transaction or event in respect of shares in the capital stock of the taxpayer.

According to the Explanatory Notes, amended subsection 39(2) will now apply to only debt and "similar obligations" what are denominated in foreign currency. Because the August 19, 2011 version of subsection 39(2) applied only to debt obligations, it did not appear to cover gains or losses on foreign currency swaps or forward contracts, where there is no debt obligation and no disposition of property. It appears that such gains and losses are now covered under the revised wording.

Securities Lending Arrangements

Bill C-48 also includes a number of proposed amendments to the securities lending rules which are contained largely in section 260 of the ITA. These rules, among other things, make it possible for taxpayers to "lend" their securities to others, without the securities lender being considered to have disposed of the loaned security for tax purposes. The lending of securities is most often carried out in order to facilitate short-selling. Almost all of the proposed changes to the securities lending rules contained in Bill C-48 were originally introduced a decade ago.

One new change contained in Bill C-48, however, expands the types of securities that may be the subject of a securities lending arrangement to include any interest as a beneficiary of a trust which interest is listed on a stock exchange. This change is achieved by expanding the proposed definition of "qualified trust unit" which had been introduced (but has not yet been enacted) in order to have the securities lending rules apply to transactions involving listed units of Canadian mutual fund trusts such as real estate investment trusts and income trusts effective for transactions entered into after 2001. As a result of the additional proposed change contained in Bill C-48, interests in foreign listed trusts, such as some exchange-traded funds, and beneficial interests in Canadian trusts listed on a stock exchange that are not mutual fund trusts under the ITA, will be qualified securities for purposes of the securities lending rules. This change is effective for transactions entered into on or after October 24, 2012.

Real Estate Investment Trusts

On December 16, 2010 (the December 2010 Proposals), the Minister of Finance announced a number of relieving amendments to the rules in the ITA governing real estate investment trusts (REITs). See our January 2011 Blakes Bulletin on Tax: Relief for REITs.

These amendments, which will make it easier for a REIT to qualify for exemption from entity-level taxation under the specified-investment flow-through rules (SIFT Rules) in the ITA, are included in Bill C-48. The most significant amendments are as follows:

  • a new 10% "safe harbour" for property owned by a REIT that would be "non-portfolio property" for purposes of the SIFT Rules, but which does not qualify as "qualified REIT property";
  • an increase from 5% to 10% in the portion of a REIT's revenues which may be derived from sources other than rent from real property, interest, capital gains from dispositions of real properties, dividends and royalties;
  • expansion of the definition of "qualified REIT property" to include non-capital properties that qualify as "eligible resale properties"; and
  • amendments to ensure that recaptured depreciation and other similar revenues are not counted as non-qualifying revenue in determining whether a particular entity qualifies as a REIT for purposes of the SIFT Rules.

Bill C-48 also introduces a new expansion to the definition of "qualified REIT property" to include Canadian corporate debt represented by bankers' acceptances, money on deposit and debts owing or guaranteed by certain government entities.

Bill C-48 also includes a new version of the previously announced revenue flow-through characterization rule for subsidiary entities of a REIT. The Bill C-48 version of this rule eliminates the requirement from the December 2010 Proposals that the interests in the subsidiary be "non-portfolio property" of the parent (which would effectively have denied flow-through characterization for revenues derived from foreign subsidiaries). Instead, flow-through characterization will apply to revenues derived from a subsidiary entity with which a particular parent entity is "affiliated" for purposes of the ITA or in which the parent entity holds more than 10% of the outstanding equity securities (by fair market value). This flow-through treatment is intended to apply iteratively through chains of subsidiaries.

Bill C-48 also introduces new recharacterization rules for REIT revenues arising from interest rate hedging arrangements in respect of real property financing and foreign exchange gains realized in respect of foreign real property investments. Where applicable, these rules will deem such revenues to have the same character as other revenues received in respect of the relevant properties. These rules are intended to work in conjunction with the flow-through characterization rule described above such that recharacterization will apply even where hedging or foreign exchange revenues are realized at a different level in a REIT's ownership structure than the level at which the property in question is held.

Foreign Spin-Offs

On October 31, 2011, amendments to the ITA were proposed to clarify that the exemption from the shareholder benefit provision in subsection 15(1) of the ITA did not apply to a reorganization of the business of a foreign corporation, unless the foreign spin-off rules in subsection 86.1(1) of the ITA applies.

Bill C-48 now proposes that amended subsection 15(1) could apply where a non-resident corporation is divided into one or more corporations pursuant to the laws of the jurisdiction that govern the non-resident corporation and a shareholder of the original corporation acquires one or more shares of the new corporations as a consequence of the division. According to the Explanatory Notes, an example of a foreign law that allows for such a division is the Mexican law that results in an "escisión" of the corporation.

Reporting of Avoidance Transactions

In the March 2010 federal budget, the Minister announced a proposal to require reporting to the Canada Revenue Agency (CRA) of certain types of tax avoidance transactions. See our June 2010 Blakes Bulletin on Tax: Mandatory Tax Disclosure – Update on Federal and Quebec Reporting Regimes.

The most recent version of these proposals was set out in proposed new section 237.3 of the ITA which was released as part of the August 2010 Proposals. Under new section 237.3, reporting is required if there is an avoidance transaction as defined for the purpose of the general anti-avoidance rule (GAAR) in the ITA and any two of three "hallmarks" of aggressive tax planning are present. Briefly summarized, the three hallmarks are as follows:

  • an advisor or promoter (or non-arm's length person) is entitled to a fee that is
    • based on the amount of the tax benefit from the transaction,
    • contingent upon obtaining of a tax benefit from the transaction or may be refunded or reduced based on failure to obtain a tax benefit, or
    • attributable to the number of persons who participate in the transaction or are provided advice or opinion as to its tax consequences;
  • an advisor or promoter (or any non-arm's length person) obtains "confidential protection" that prohibits disclosure of the details or structure of the transaction;
  • there is "contractual protection" in the nature of
    • any form of insurance (other than professional liability insurance) or other protection which
      • protects against the failure of the transaction to achieve any tax benefit, or
      • pays for or reimburses any amount in any dispute in respect of a tax benefit, or
    • any form of undertaking to provide assistance to a person in the course of a dispute in respect of the tax benefit.

Where an avoidance transaction meets at least two of the three hallmarks, prescribed information must be reported to the CRA by June 30 of the year after the year in which the transaction occurs. There are penalties for failure to report and, if the reporting obligation is not complied with, the anticipated tax benefits may be denied.

The reporting requirement applies to:

  • any person who obtains a tax benefit from a reportable transaction;
  • any person who enters into the transaction for the benefit of a person who obtains a tax benefit; and
  • any advisor or promoter who is entitled to a contingent fee of a type described above or to a fee in respect of contractual protection described above.

Bill C-48 proposes a change to the draft legislation which specifically confirms that, as previously announced in a comfort letter given to the Canadian Bar Association, the reporting obligation does not apply to a lawyer in respect of information otherwise required to be reported, if the lawyer is acting in the capacity of an advisor in respect of the reportable transaction and, based on reasonable grounds, the lawyer believes that solicitor-client privilege exists in respect of the information.

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.

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