PLEASE NOTE: THIS INFORMATION WAS ORIGINALLY SUBMITTED BY COOPERS & LYBRAND, CANADA
International tax provisions in Canada's recent federal budget are the latest in a long list of measures designed to require full disclosure by those earning income in Canada and to target tax avoidance.
Although absent from the 1998 budget, new transfer pricing legislation requires transactions with related non-residents to occur on arm's length terms and conditions. Transactions failing to meet this test may be adjusted and a penalty of 10% of the adjustment may be assessed. Contemporaneous documentation evidencing arm's length pricing is the best defence. The new legislation will apply for taxation years beginning after 1997 but the levying of penalties is delayed one year.
Related Party Reporting
Form T106, used by corporate taxpayers to report transactions with related non-residents since 1988, must now be filed by individuals, partnerships and trusts after 1997. Taxpayers with transactions with related non-residents less than $1 million in aggregate in the year are exempt from filing.
The first filing deadlines for foreign information reporting announced in March of 1996 are in 1998. The requirement to report foreign investment property over $100,000 has been delayed to April 30, 1999 pending further review.
1998 FEDERAL BUDGET CORPORATE MEASURES
Treaty Based Disclosure
For taxation years beginning after 1998, non-resident corporations carrying on business in Canada must file an information return disclosing if they are claiming a treaty-based exemption from Canadian tax. This will identify those non-resident companies carrying on business in Canada without Canadian permanent establishments.
Tax Deferred Foreign Mergers
Although Canadian domestic amalgamations can occur on a tax-deferred basis, Canadian tax deferral has not been provided for foreign triangular amalgamations whereby shares of one or more merging foreign corporations are exchanged for shares of a foreign corporation which controls the merged corporation. After February 24, 1998 such mergers can occur on a tax deferred basis for Canadian tax purposes. In addition, a Canadian taxpayer that previously exchanged shares in a triangular merger in a taxation year that will not become statute-barred before 1999, may elect to have these new rules apply. Canadian taxpayers may wish to review previously taxable mergers, to determine if they can now elect to gain tax deferred treatment.
Expansion of Anti-Avoidance Rules: Corporate Immigration and Surplus Stripping
Current Canadian tax rules allow a non-resident company that owns a Canadian subsidiary to immigrate to Canada and defer Canadian tax on the appreciation of Canadian assets and Canadian operating surplus. These rules can be avoided by selling the immigrating corporation's shares prior to immigration to a Canadian resident company for shares with paid up capital and cost equal to fair market value. Thereafter, surplus can be paid as dividends up the Canadian corporate chain and the shares sold free of tax.
Anti-avoidance rules are introduced effective to corporate immigrations after February 23, 1998 to prevent such planning:
- such companies will be deemed to have sold all their property, including Canadian property, at fair market value,
- dividend will be deemed received from subsidiary Canadian companies equal to the difference between the fair market value and paid-up capital of the Canadian subsidiary's shares,
- similar changes will apply to an immigrating corporation that previously had a Canadian branch. To prevent surplus stripping, the corporation will be subject to Canadian branch tax on its Canadian surplus in the year prior to immigration.
Existing anti-avoidance rules apply to prevent the tax free conversion of otherwise taxable surplus of a Canadian company to tax free proceeds of disposition on the sale of the company's shares to another non arm's length Canadian company. For such dispositions after February 23, 1998, these rules will now also apply to the transfer of shares of all Canadian resident companies to any other Canadian resident company, whether or not it is at arm's length. In addition, these rules will apply where the non-resident vendor is a partnership where any non-resident person (or a non-resident-owned investment corporation) is a majority partner. These rules will not apply where the non-resident vendor transferring Canadian shares is subject to taxation in Canada and Canada's right to tax the transfer is not prevented by Treaty.
Canada's Domestic and Treaty Tax Rules Harmonized To Prevent Abuse
For 1998 and subsequent taxation years the budget proposes several changes to correct anomalies that exist between Canada's domestic rules and its network of tax treaties. These amendments imply that it may be possible (subject to anti-avoidance provisions) to defend aggressive tax filings in taxation years ending prior to 1998.
- Individuals claiming exemption from Canadian tax due to non-resident status provided by a tax treaty will be deemed non-resident of Canada for Canadian domestic tax purposes. This will prevent them avoiding Canadian withholding tax on Canadian sourced interest and dividends, claiming the benefits of Canadian controlled private corporation status for Canadian companies they control, claiming principal residence exemptions and will deny them continued ability to contribute to an RRSP in respect of foreign employment income. It may still be possible to defend such planning for taxation years that end prior to 1998.
- Canada taxes non-residents on their "taxable income earned in Canada" i.e. Canadian sourced income from employment, business and gains from the disposition of taxable Canadian property. Pre-budget rules do not directly exclude treaty exempt income or losses from this definition and thus it is technically possible prior to 1998 taxation years for a non-resident to deduct Canadian business losses from other Canadian sourced income even though income from the Canadian business would have been exempt from Canadian tax due to a tax treaty provision (i.e. no permanent establishment in Canada). Such losses will no longer be deductible as of the 1998 taxation year.
- A Canadian resident may deduct from Canadian tax payable, foreign tax paid on foreign income up to the equivalent amount of Canadian tax paid on the foreign income. For taxation years ending prior to 1998, the foreign tax credit limit is calculated separately for each foreign country and is generally based on the proportion of Canadian tax that foreign income (including foreign income on which there is no foreign tax due to a treaty based exemption) bares to world-wide income but cannot exceed foreign tax paid. The budget proposes to exclude treaty protected foreign income from the foreign tax credit calculation thus ensuring that the foreign tax credit cannot be inflated by foreign income on which no foreign tax is paid. Unless certain conditions are met, former residents of Canada are subject to tax in Canada on amounts paid by their Canadian employers. Beginning in 1998, amounts paid by Canadian employers to former residents will no longer be subject to tax in Canada if the payments are taxable in their country of residence. Canada will tax these amounts only if the payments are exempt from foreign tax because of a tax treaty.
Amounts Owing by Non-Residents
Canadian corporations must accrue interest income at prescribed rates on loans made to non-residents if the loans are outstanding greater than one year. Exceptions are provided if the loan to a shareholder or other related non-resident is considered a shareholder appropriation (in this event the loan will be deemed a dividend subject to withholding tax) or if the loan was made to a non-resident "subsidiary controlled corporation" to be used in that corporation's business for the purpose of gaining or producing income. Effective for taxation years and fiscal periods that begin after February 23, 1998:
- all amounts owing, directly or indirectly, by non-residents (i.e. trade accounts receivable and inter-company receivables) will now attract interest income,
- loans to a subsidiary controlled corporation will attract interest if the loan is not used by it to carry on an active business. Thus loans will attract interest if they are to first tier foreign subsidiaries to allow them to earn income from interest and dividends,
- avoidance of these rules by causing the loans to be made by a trust or partnership will no longer be possible where a corporation resident in Canada is a beneficiary or partner of the trust or partnership.
It is commonplace with many international employee transfers to reimburse the employee for relocation costs, often including cash payments, to absorb losses arising on the disposition of the former home or to assist with incremental financing of the new home. The trend in tax jurisprudence has allowed tax free receipt of reimbursement of a loss incurred on the sale of an employee's former home or a subsidy for interest payable on the new mortgage. The budget introduces specific legislation that will result in taxation of employer reimbursements or subsidies provided to finance the employee's new or former home. In addition, one-half of the employer reimbursement in excess of $15,000 that relates to a loss on the sale of a former home will be taxable. Grandfathering provisions will allow the more generous treatment allowed by the courts to apply to payments made prior to 2001 if the employee begins work at the new location before July, 1998.
Foreign Tax Credit Abuse
Canadian taxpayers are subject to income tax on their world-wide income. To prevent double taxation of income earned in foreign countries, Canadian taxpayers are allowed to claim a foreign tax credit (FTC) for income tax paid in a foreign jurisdiction which is generally equal to Canadian tax otherwise payable on that income but not to exceed the foreign income tax paid. Generally, the Canadian tax is computed by prorating total Canadian tax by the ratio of foreign income to total income. To maximize the FTC a Canadian taxpayer could acquire (under a short term loan or repurchase arrangement) a foreign security (debt or share) immediately before a dividend or interest payment was to occur. Immediately thereafter the security would be sold back to the original owner. Although there may be little gain or even a loss on disposition, the Canadian taxpayer could receive a higher FTC under the pro rata formula. After February 23, 1998, for such transactions which are flipped within 1 year, the amount of FTC will be restricted to 40% of the gross profit realized for business income and to 30% for non-business income. In addition, no FTC will be allowed if the net foreign profit on the disposition of a foreign property is not "material" when compared to the foreign income tax paid. No indication is given of what is meant by the materiality test.
Goods & Services Tax
To encourage tourism, rebates are available under the GST/HST for certain purchases by tourists and non-resident convention organizers. The Budget proposes to broaden the rebates to include meals relating to certain foreign conventions, and campsite fees. Measures were also introduced to further simplify rebate claim procedures.
Countervailing and Anti-dumping Duties
Countervailing and anti-dumping duties paid to foreign countries after February 23, 1998 can now be deducted in the year paid and subsequent refunds must be included in computing income in the year refunded.
The information provided herein is for general guidance on matters of interest only. The application and impact of laws, regulations and administrative practices can vary widely, based on the specific facts involved. In addition, laws, regulations and administrative practices are continually being revised. Accordingly, this information is not intended to constitute legal, accounting, tax, investment or other professional advice or service.
While every effort has been made to ensure the information provided herein is accurate and timely, no decision should be made or action taken on the basis of this information without first consulting a Coopers & Lybrand professional. Should you have any questions concerning the information provided herein or require specific advice, please contact your Coopers & Lybrand advisor, or: David W. Steele, Coopers & Lybrand, 145 King Street West, Toronto, Ontario M5H 1V8, Canada on Fax: 1-416-941-8415 E-mail: Click Contact Link
David W. Steele PricewaterhouseCoopers 145 King Street West Toronto, Ontario M5H 1V8 Canada Fax: 1-416-941-8415 E-mail: Click Contact Link
Click Contact Link