Canada: Draft Regs For Novel Use Of TIEAs

Last year, Canada's controversial 2007 spring budget1 effectively posted a notice to the tax havens of the world: Tell us, through tax information exchange agreements, about the undisclosed income dishonest Canadians are hiding in your banks and trust companies and you will be rewarded with investment by honest Canadians, motivated by tax incentives we will give them; but refuse and we will impose punitive tax on honest Canadians who venture near your shores. (For prior coverage, see Doc 2007-6959 or 2007 WTD 55-1.)

The second legislative leg of that carrot and stick approach2 to inducing TIEAs was announced July 14 with draft amendments to the foreign affiliate regulations that would provide tax exemptions (the carrot) to Canadians who carry on business in TIEA countries.3

The first leg (the stick component) was enacted in December 2007 in the form of rules (which may not come into effect for several years) that will immediately tax profits — whether or not repatriated — that are earned in countries that have failed to effectuate TIEAs with Canada within five years of being invited to do so. Following is a brief review of Canada's new approach to TIEAs.


Since 1976, tax treaties have been the keys that unlock the effects of a European-style participation exemption or territorial tax system for Canadian multinationals operating abroad. A territorial tax system exempts the parent company from home-country tax on dividends received from its foreign subsidiaries. But in accordance with the March 2007 budget and the draft regulations issued July 14, another type of treaty — a tax information exchange agreement — will also swing open the doors to the home-country tax exemption. And that will potentially be effective this year.

Under the current rules (often referred to as the foreign affiliate system or the exempt surplus system), a Canadian corporation does not pay any permanent tax on dividends it receives out of the exempt surplus of a foreign affiliate.4 For purposes of these rules, a nonresident corporation is a foreign affiliate if a Canadian entity owns 10 percent or more of the shares of any class of the nonresident corporation.5 The exempt surplus is the after-tax active (or deemed active) business profits of an affiliate that is resident in a designated treaty country (DTC), provided that those profits are earned in that or any other designated treaty country.6 Exempt status requires residency in the DTC for purposes of the treaty between Canada and the DTC, and as understood under Canadian domestic law (based on mind and management). A DTC under current domestic law, and since the introduction of the system in percent, by both votes and value, of the affiliate and it does not have certain affiliated party nexus to the affiliate. The underlying exemption from permanent tax arises under paragraph 113(1)(a) of the ITA. 1976, is a country with which Canada has a comprehensive income tax treaty7 in force.

Thus, because Canada has no treaties with pure tax havens (such as Bermuda, the Cayman Islands, and the British Virgin Islands), the profits of foreign subsidiaries that are based there or earned there do not qualify as exempt surplus. Instead, they are classified as taxable surplus8 and are treated, on repatriation, much like dividends received by U.S. or U.K. corporations from foreign subsidiaries — namely, they are taxed on a gross-up and credit basis.9

The flip side of this system — in which the foreign affiliate is a controlled foreign affiliate, or CFA, meaning that it is controlled by the relevant Canadian shareholder, by that shareholder and certain other unaffiliated Canadians or affiliated nonresidents, or by certain unaffiliated Canadians10 — is that passive or deemed passive income (foreign accrual property income)11 of a CFA is immediately taxed through attribution12 in the hands of the Canadian shareholder (whether corporate or noncorporate).

The adverse part of the new rule (immediate attribution of active business profit) will arise when a CFA has earned income from a nonqualifying business that is connected to the earning of income in a nonqualifying country.13 A nonqualifying country is one with which Canada has no tax treaty and that has failed to enter into a TIEA with Canada within 60 months after Canada has ''sought by written invitation to enter into negotiations for a comprehensive tax information exchange agreement.'' In principle, the effective-date rules are such that it appears unlikely that any country will be a nonqualifying country until 2014. Indeed, at this point, there have been no announcements by the Canadian government regarding TIEA negotiations.
The favorable aspect of the system will arise when a country that does not have a tax treaty with Canada enters into a TIEA that has been brought into force. In particular, the July 14 draft proposals would extend the entire current exempt surplus system to countries with which a TIEA has come into force. That would be effectuated through the simple mechanism, set out in draft revised subsection 5907(11), of including as a designated treaty country a country with which ''a comprehensive tax information exchange agreement, in respect of that sovereign jurisdiction . . . has entered into force and has effect.'' The draft would make that applicable beginning this year, and for proposed new subsection 5907(11.11), the effective date would be the beginning of the tax year of the foreign affiliate in which a TIEA comes into force — conceptually, as early as January 1 of this year.


In some ways, it is difficult to know what to make of this TIEA development. For example, although more than 15 months have elapsed since the project was announced in March 2007, and although hardly a week goes by without word of countries entering into TIEAs, there has not been, as already noted, any indication from the Canadian government that it has even started negotiating TIEAs, let alone entering into any. Further, following the April 25 release of an interim report by the government-appointed Advisory Panel on Canada's System of International Taxation that clearly signals that the panel favors extending the exempt surplus system to all countries,14 there has been speculation in Canadian circles that the lifespan of the TIEA system might in fact be quite short. Finally, it is difficult to come to terms with the philosophical underpinnings of the carrot and stick approach inherent in this initiative in the context of a mature and developed country such as Canada. But only time will tell what effect it actually has on the foreign operations of Canadian-based multinationals.


1 The March 2007 budget had proposed severe restrictions on the deductibility of financing costs related to foreign acquisitions. However, those proposals were withdrawn by the government two months later amid controversy, and the government instead announced a different restriction in this area, specifically regarding double-dip financings. That provision was later enacted as new section 18.2 of the Income Tax Act, Canada, as amended in December 2007 as part of Bill C-28.

2 See Lorne Saltman, ''The Carrot and the Stick: Canada's Approach to TIEAs,'' Tax Notes Int'l, Dec. 3, 2007, p. 951, Doc 2007-24515, or 2007 WTD 237-12.

3 Legislative Proposals and Explanatory Notes relating to the Income Tax Act, the Excise Act, 2001, and the Excise Tax Act, Department of Finance, Ottawa, Canada, July 14, 2008.

4 It may pay a potentially fully refundable tax, under Part IV of the act, on such dividends if it does not own more than 10 percent, by both votes and value, of the affiliate and it does not have certain affiliated party nexus to the affiliate. The underlying exemption from permanent tax arises under paragraph 113(1)(a) of the ITA.

5 That status also may arise with as little as a 1 percent ownership if certain affiliated parties own at least 9 percent (subsections 95(1) and 95(4) of the ITA).

6 Technically, such earnings are considered to be exempt earnings, a component of exempt surplus, under section 5907(1) of the Income Tax Regulations. Note that Canada has tax treaties with 86 countries.

7 Section 5907(11) of the Income Tax Regulations refers to a ''comprehensive agreement or convention for the elimination of double taxation on income.''

8 Technically, such profits comprise taxable earnings, a component of taxable surplus, under section 5907(1) of the Income Tax Regulations.

9 This actually involves grossed-up deductions of foreign taxes calibrated to give the effect of a credit, in accordance with paragraph 113(1)(b) and (c) of the ITA and relevant provisions under the Income Tax Regulations.

10 Subsection 95(1) of the ITA.

11 Id.

12 Section 91 of the ITA.

13 These notions were added to the definition of FAPI by Bill C-28.

14 For a detailed discussion, see Nathan Boidman, ''Reforming Canada's International Tax: An Interim Report,'' Tax Notes Int'l, May 19, 2008, p. 613, Doc 2008-9581, or 2008 WTD 100-9.

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.

To print this article, all you need is to be registered on

Click to Login as an existing user or Register so you can print this article.

In association with
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.


Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.


Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.


A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.


This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.


If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.


This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at and we will use commercially reasonable efforts to determine and correct the problem promptly.