Current Canadian tax law creates barriers to efficient
cross-border investment. In particular, many international
private equity investors, particularly US-based venture funds,
have complained about the additional time and expense
associated with exiting Canadian-based investments. Proposed
changes to the Section 116 withholding and clearance
certificate obligations, announced in the federal budget on
February 26, 2008, should come as good news to US venture
capital investors active in Canada.
Under current Canadian tax law, a US-based fund investing
directly in a Canadian operating company, on a disposition,
will generally be required to obtain a certificate from the
Canada Revenue Agency (typically referred to as a "Section
116 Certificate" after the relevant section in the
Income Tax Act (Canada)), file a Canadian tax return
and provide certain details regarding each of its limited
partners. Private equity sponsors are often precluded from
doing this under the terms of their limited partnership
agreements. Even if they are permitted to do so, compliance
with the requirements can be an organizational headache.
To avoid these administrative burdens, many US venture funds
have resorted to structuring their investments in Canada
through an exchangeable share transaction. These funds invest
directly in a newly established Delaware company into which all
of the shares of the existing Canadian operating company are
exchangeable upon the occurrence of certain events.
Other US funds have been known to structure their Canadian
investments through a corporate vehicle resident in a third
jurisdiction (e.g., Barbados or Luxembourg) that mitigates the
administrative burden and may otherwise be more favourable from
a tax-planning standpoint.
In many cases, these complexities have resulted in
significantly higher transaction costs or have chased away
investors that might otherwise have considered investing in
Canada. In fact, some commentators have blamed the lack of
venture funds available to Canadian entrepreneurs on these tax
In the 2008 federal budget, the Canadian government proposed
revisions to the Section 116 withholding and clearance
certificate obligations, and the hope is that these revisions
will alleviate some of the cost and inconvenience associated
with certain cross-border transactions. The effect of the
proposals may be to ease the compliance burden imposed on
certain non-resident sellers and to allow such sellers to avoid
the related purchase price withholding on closing.
To qualify for the proposed relief, several requirements
must be satisfied. Given the potentially significant exposure
to buyers seeking to hold-back, buyers will need to diligently
assess whether the relevant criteria can be adequately
satisfied. In certain instances, opinions, representations and
certificates may be inadequate to provide buyers with the
required level of assurance.
On a separate note, but relevant to venture funds, the
budget also proposed enhancements to Canada's
scientific research and experimental development incentives, in
particular for R&D undertaken by Canadian-controlled
private corporations and for certain eligible R&D to be
undertaken outside of Canada.
For a more detailed discussion of the revisions to the
Section 116 withholding and clearance certificate obligations,
please read our firm's
federal budget commentary.
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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In late October 2016, the federal government introduced Bill C-29, Budget Implementation Act, 2016, No. 2, which addresses a wide variety of topics, including proposed changes to the Bank Act (Canada).
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