The government is proposing changes to the Income Tax Act which could impact many Canadian corporations with foreign affiliates.
Of particular concern are situations where controlling interests in such corporations are owned by
- individuals emigrating from Canada, or
- trusts or estates where any beneficiaries may be, or may become, non-residents of Canada.
Anyone who thinks they could be caught should keep an eye out in
the coming months to see what happens with these proposals.
Depending on what changes are passed, some may wish to take steps
to mitigate potential added tax costs.
Proposed changes to FAD rules
Since being introduced in 2012, the Income Tax Act's Foreign Affiliate Dumping Rules (the "FAD" rules) were generally of little concern to most because of the rules limited applicability to circumstances with a non-resident parent corporation controls a corporation resident in Canada (a "CRIC"), which in turn invests in a foreign affiliate.
However, earlier this year, first in the federal budget in March and then in revised legislative proposals in July, the Department of Finance proposed changes to broaden the application of the FAD rules so they would not just apply to CRIC's controlled by non-resident corporations, but also to cases where a CRIC is "controlled" by non-resident individuals, including through a trust or estates.
With respect to trusts and estates in particular, under the proposed FAD rules a trust or estate is assumed to be a corporation with a capital stock of 100 common shares (the "Contrived Shares"), and each beneficiary under the trust owns a portion of shares equal to their interest in the trust based on fair market value ("FMV").
If the beneficiaries interest in the trust or estate is discretionary, then the FMV of each beneficiaries' interest is deemed to be equal to 100% of the Contrived Shares unless the trust is
- a resident of Canada and
- "it cannot reasonably be considered that one of the main reasons for the discretionary power is to avoid or limit the application of" the FAD rule.
And no, it's not entirely clear how one would prove that this second requirement has been met.
The proposed changes could cause the FAD rules to apply in several common situations, including, but not limited to, when:
- an individual controlling a CRIC with a foreign affiliate emigrates for personal or business reasons (such as to grow the foreign subsidiary), becoming a non-resident;
- a beneficiary of a discretionary family trust resident in Canada becomes a non-resident of Canada and the family trust controls a CRIC with a foreign affiliate; and
- the death of an individual results in control of a CRIC with a foreign affiliate being left to an estate with non-resident executors or beneficiaries.
If passed, the proposed amendments would be effective retroactively to March 19, 2019, the date of the 2019 budget.
What to do if you think you, your estate or your trust might be caught
The question is what should you do if you think you, your estate or your trust might be caught by these proposed changes.
The tax consequences of having the FAD rules apply are quite severe – resulting in constructive upstream dividends subject to non-resident withholding tax. As a result, it is almost certainly in taxpayers best interests to avoid their application if possible.
Should taxpayers, therefore, be reorganizing corporations, amending trust deeds and revising wills?!
Well... maybe not yet. The changes have not yet been implemented, and it is not certain what form they will finally take.
Due to the complex nature of the FAD rules and the fact that the proposed changes of the rules are fraught with unintended implications and uncertainty, the Joint Committee on Taxation of the Canadian Bar Association and Chartered Professional Accountants of Canada issued a submission to the government on May 24, 2019 outlining issues with the proposed FAD rules and provided recommendations for amendments.
On July 30, 2019, the Department of Finance released new proposed legislation to implement the proposed changes and have invited comments by October 7, 2019.
The July 30, 2019 proposed legislation appears to have partially addressed at least one of the main concerns tax professionals had with the initial proposed legislation: the proposed legislation released with the budget would have automatically had all beneficiaries of a discretionary trust deemed to own 100% of the Contrived Shares where the new July 30, 2019 proposed legislation provides an exclusion for Canadian trusts where it cannot reasonably be considered that one of the main reasons for the discretionary power is to avoid or limit the application of the FAD rules. That being said, without further guidance from the CRA and the Courts, it is unclear how useful that exclusion will actually be.
In any event, it is uncertain exactly what form the proposed changes to FAD rules will actually take. As a result, it is difficult to determine what changes, if any, would be advisable with regards to corporate structure, wills and trust deeds at this time.
However, it is definitely worth considering if you, your estate or trust might be caught and, if you think it might be, keep your eyes open for future posts on this blog addressing this topic further once we have more 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.