On January 1, 2011, Canada's first tax information exchange agreement (TIEA), between Canada and the Netherlands Antilles, entered into force. Although the Netherlands Antilles formally ceased to exist on October 10, 2010, the Netherlands government has confirmed that the TIEA will apply to the successors of the Netherlands Antilles, which are the islands of Curacao, Bonaire, Saba, Saint Maarten and Saint Eustatius. The entry into force of Canada's first TIEA offers the Canada Revenue Agency (CRA) access to additional tax information, and provides Canadian taxpayers with greater flexibility and choice of jurisdictions for outbound investments. Canada's TIEAs with ten other jurisdictions are expected to enter into force later in 2011.
A TIEA is an agreement between two jurisdictions pursuant to which the jurisdictions may request and share certain information that is relevant to the determination, assessment and collection of taxes, the recovery and enforcement of tax claims, and the investigation or prosecution of tax matters. Foreign bank records and information regarding the ownership of companies, partnerships, trusts and other persons are examples of the information that may be requested and shared under a TIEA. TIEAs will thus be an important tool for the CRA in enforcing Canada's tax rules.
Impact on Canada's Outbound Tax Rules
TIEAs will also have an important impact on outbound tax planning from Canada. Canada has attempted to encourage foreign countries to enter into TIEAs by extending the favourable "exempt surplus" regime to foreign affiliates resident in countries that have a TIEA with Canada that has entered into force (rather than just countries that have entered into an income tax treaty with Canada).1 Very generally, dividends received by a Canadian corporation out of the exempt surplus of a foreign affiliate are not taxed in Canada. Exempt surplus includes earnings of a foreign affiliate that is resident in, and carrying on an active business in, a country with which Canada has an income tax treaty or a TIEA. In contrast, dividends received by a Canadian corporation out of the taxable surplus of any applicable foreign affiliate are generally taxable in Canada subject to a grossed-up deduction for foreign taxes. Taxable surplus includes most passive earnings and active business earnings of a foreign affiliate that is resident in, or carrying on business in, a country with which Canada has neither an income tax treaty nor a TIEA. Special rules may deem certain passive income (such as interest or royalties) to be included in exempt surplus if received by a foreign affiliate resident in a tax treaty or TIEA jurisdiction and deductible in computing the exempt earnings of another foreign affiliate.
A foreign affiliate may earn exempt surplus in a TIEA country if the TIEA has entered into force prior to or during the relevant taxation year of the foreign affiliate. Once a TIEA has entered into force, it will be deemed to have effect from the first day of the foreign affiliate's taxation year that includes the entry into force date. Accordingly, a foreign affiliate will be entitled to earn exempt surplus throughout its taxation year in which the TIEA enters into force.
In addition to extending the favourable exempt surplus regime, Canada has further encouraged countries to enter into TIEAs with Canada by extending its anti-deferral foreign accrual property income (FAPI) regime to income earned in certain countries that do not have a TIEA with Canada. A Canadian taxpayer is subject to tax in Canada on a current basis on its proportionate share of any FAPI earned by a controlled foreign affiliate, regardless of whether those earnings are distributed. The FAPI regime applies to all income (including active business income) earned by a foreign affiliate that is carrying on business through a permanent establishment in a country that does not have a TIEA or tax treaty with Canada if a TIEA was not entered into within five years of commencing negotiations or Canada seeking to enter into negotiations with that country. To date, there are no countries to which this deemed FAPI rule applies.
Status of Canada's other TIEAs
In addition to the TIEA with the Netherlands Antilles, Canada has signed TIEAs with ten other jurisdictions2 and has entered into TIEA negotiations with fourteen others.3 Very generally, for a TIEA to enter into force, the TIEA must be ratified by both jurisdictions, and each jurisdiction must then notify the other that ratification has occurred. Certain TIEAs also contain special timing clauses providing for when the TIEA will enter into force.4 For ratification to occur in Canada, the Minister of Foreign Affairs must first table the TIEA in Parliament. If there is no debate on the TIEA within 21 days of the TIEA being tabled, ratification occurs automatically.
On December 8, 2010, Canada's ten other signed TIEAs (with Anguilla, Bahamas, Bermuda, Cayman Islands, Dominica, Saint Lucia, Saint Vincent and the Grenadines, San Marino, St. Kitts and Nevis, and Turks and Caicos) were tabled in Parliament. Because these TIEAs had not been tabled for 21 days prior to Parliament's winter recess, the 21 day period will continue when Parliament resumes on January 31, 2011 and will likely be ratified by Canada in February of 2011. After ratification, each of these ten other TIEAs will enter into force once Canada and the relevant foreign jurisdiction notify each other that ratification is complete in both jurisdictions, and any special timing clauses in the relevant TIEA have been satisfied.
Advantages of Expanded TIEA Regime
The entry into force of Canada's TIEAs will allow greater flexibility and choice of jurisdictions for outbound Canadian investment eligible for Canada's favourable exempt surplus regime, including jurisdictions that do not levy any significant corporate income taxes.
While the existence of a TIEA with Canada will allow foreign affiliates to earn exempt surplus on active business income earned in the TIEA jurisdiction, TIEAs do not provide other advantages available under many income tax treaties (e.g., permanent establishment protection on certain business activities, reduced withholding tax rates on interest, dividends and royalties, or a capital gains exemption on the sale of shares). Therefore, in some cases using a corporation that is resident in a country that has a tax treaty with Canada (and that qualifies for benefits under that treaty) will be preferable to a company that is resident in a TIEA jurisdiction (such as for inbound investments into Canada). Also, the treaty network of the jurisdiction in which a foreign affiliate is resident may be important for various outbound investments from Canada.
1 Very generally, a foreign affiliate is a non-resident corporation in which the Canadian shareholder owns, directly or indirectly, at least one percent of the shares of any class and at least ten percent of the shares of any class together with related persons.
2 These jurisdictions are: Anguilla, Bahamas, Bermuda, Cayman Islands, Dominica, Saint Lucia, Saint Vincent and the Grenadines, San Marino, St. Kitts and Nevis, and Turks and Caicos.
3 These jurisdictions are: Aruba, Bahrain, Belize, British Virgin Islands, Brunei, Cook Islands, Costa Rica, Gibraltar, Guernsey, Isle of Man, Jersey, Liberia, Liechtenstein, and Vanuatu.
4 For example, the TIEA with Bermuda will enter into force on the 30th day after the notices of ratification are completed.
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.