This past year, the Federal Government of Canada introduced a number of measures to address international tax matters, including the ability of the Canada Revenue Agency (CRA) to collect information to counter tax avoidance and evasion. It also saw the introduction of a bill to implement the multilateral convention on BEPS. Finally, the courts addressed a number of issues including a re-examination of common interest privilege and the ability of the CRA to collect information, as well as other matters that may be of interest to international tax planners.
Statutory developments
Surplus stripping
The Tax Act contains provisions that are intended to prevent a non-resident shareholder from entering into transactions to extract free-of-tax a Canadian corporation’s surplus in excess of the paid-up capital (PUC) of its shares, or to artificially increase the PUC of such shares. When applicable, this rule can result in a deemed dividend to the non-resident, resulting in withholding tax, or suppress the PUC that would otherwise have been created as a result of the transactions.
The Federal Government has noted that the current rules do not address situations where a non-resident person disposes of an interest in a partnership that owns shares of a Canadian subject corporation. To ensure that the underlying purposes of the cross-border anti-surplus stripping rule, and the corresponding corporate immigration rule, are not frustrated by transactions involving partnerships or trusts, the Federal Government introduced legislation in July of 2018 to amend these provisions to add comprehensive “look-through” rules for such entities. The rules will allocate the shares of a Canadian corporation owned by a partnership or trust to its members or beneficiaries, as the case may be, based on the relative fair market value of their interests. The proposed rules also address tiered trust and tiered partnership structures and contain an anti-avoidance rule to deal with discretionary interests in trusts.
In addition, the Federal Government proposes rules that would deem a dividend to be paid where a Canadian corporation increases its PUC by way of a conversion of contributed surplus that arose while the corporation was non-resident.
Foreign divisive reorganisations
As discussed in World Tax 2018, in September of 2016 the Federal Government introduced legislation dealing with divisive reorganisations of non-resident corporations. In July of 2018 the Federal Government proposed to replace portions of this legislation, providing greater certainty with respect to various tax consequences of foreign divisive reorganisations.
The proposed legislation is substantially similar to that introduced in 2016, namely, where a non-resident corporation is divided under the laws of its jurisdiction and new shares are received by a shareholder on a pro rata basis, there is deemed to be a dividend paid to the shareholder rather than a taxable benefit. Conversely, if shares are not received on a pro rata basis, a shareholder is deemed to have received a taxable benefit from the non-resident corporation. However, unlike the previous legislation, the proposed legislation applies for the purposes of the Tax Act more generally and is not limited to the specific subsection.
In addition, the proposed legislation, like the previous legislation, deems the property of the corporation that is divided to have been disposed of for proceeds of disposition equal to its fair market value and acquired by a new corporation for the same amount. This may result in tax consequences under the Tax Act where the divided corporation held taxable Canadian property or was a foreign affiliate of the shareholder. To address the latter situation, the Federal Government proposes regulations to allow surplus recognition where asset sales are instead, for foreign commercial reasons, structured as share sales. Where such a transaction is structured primarily for Canadian tax reasons, the Federal Government has noted that the anti-avoidance rule in the regulations may apply.
Foreign affiliates
A Canadian resident taxpayer’s share of the income of a foreign affiliate from an active business is not taxed until such time as it is paid as a dividend by the affiliate to the taxpayer and can often be received on a tax-free basis (such as where a foreign affiliate has income from an active business carried on by it in a country with which Canada has a tax treaty or a tax information exchange agreement [TIEA] and it is resident in such a country). However, certain types of income earned by a controlled foreign affiliate (i.e., income from property, from a business other than an active business and from other specified sources) results in taxation in the hands of a taxpayer on an accrual basis, whether or not a dividend is paid. This income is defined as foreign accrual property income (FAPI).
Income from an “investment business” carried on by a foreign affiliate is included in FAPI. An investment business is generally defined as a business the principal purpose of which is to derive income from property. However, an investment business does not include a business carried on by a foreign affiliate if certain conditions are satisfied. One of these conditions, in general terms, is that the affiliate employ more than five full-time employees (or the equivalent) in the active conduct of the business. This condition is sometimes referred to as the ‘six employees test’. This test applies to each separate business carried on by a particular foreign affiliate.
In the 2018 Federal Budget (Budget 2018), the Federal Government suggested that certain taxpayers have been engaging in tax planning with other taxpayers in similar circumstances seeking to meet the six employees test and otherwise avoid FAPI. This planning involves grouping of financial assets together in a common foreign affiliate in order to carry on investment activities outside of Canada through that affiliate. Each taxpayer retains control over their particular assets through a “tracking arrangement”.
In July of 2018, the Federal Government proposed legislation amending the investment business definition so that, where a taxpayer holds a “tracking interest” in a person or partnership, the tracked properties and activities carried out by the tracked entity will be deemed to be a separate business carried on by the affiliate. Each separate business of the affiliate will therefore need to satisfy each relevant condition in the investment business definition, including the six employees test, in order for the affiliate’s income from that business to be excluded from FAPI.
The proposed legislation also addresses the use of tracking arrangements to avoid controlled foreign affiliate status; the FAPI of a foreign affiliate of a taxpayer is included in the taxpayer’s income on an accrual basis only where the affiliate is a controlled foreign affiliate of the taxpayer. The proposed legislation would deem a foreign affiliate of a taxpayer to be a controlled foreign affiliate of the taxpayer if the taxpayer holds a tracking interest in the affiliate and the FAPI of that affiliate, or another affiliate of the taxpayer, is greater than nil. The proposed rules contain elective provisions as an alternative to the deemed control foreign affiliate rule where the taxpayer is unable to reasonably comply with the FAPI computational rules, due to a lack of information as to the overall operations of the affiliate, or where the tracked portion of the affiliate, if it was a separate corporation, would not be a controlled foreign affiliate of the taxpayer.
Finally, the Federal Government proposes to bring the information return deadline in respect of a taxpayer’s foreign affiliates in line with the taxpayer’s income tax return deadline by requiring the information returns to be filed within six months of the end of the taxpayer’s taxation year. Currently, a taxpayer’s information return in respect of its foreign affiliates is not due until 15 months after the end of its taxation year.
Extended reassessment periods
Budget 2018 proposed to extend the period during which a taxpayer may be reassessed by the CRA in respect of an income tax return. For most taxpayers, including those holding shares of foreign affiliates, the CRA generally has three or four years after its initial assessment in which to audit and reassess the taxpayer’s tax liability in respect of that particular year.
A three-year extended reassessment period currently exists in respect of assessments made as a consequence of a transaction involving a taxpayer and a non-resident with whom the taxpayer does not deal at arm’s length. Although this three-year extension currently applies to many transactions involving foreign affiliates, it does not apply in all relevant circumstances. By way of proposed legislation introduced in July of 2018, the Federal Government proposes to extend the reassessment period for a taxpayer by three years in respect of income, loss or other amount arising in connection with a foreign affiliate of the taxpayer.
Further, if a taxpayer incurs a loss in a taxation year and carries the loss back to deduct against the taxpayer’s income in a prior taxation year, the CRA has an additional three years to reassess that prior year. This loss carryback reassessment period is intended to ensure that where a loss arises in a taxation year and is carried back to be used in a prior taxation year, the loss carried back to the prior taxation year cannot become statute-barred before the end of the reassessment period for the taxation year in which the loss arose.
The loss carryback reassessment period does not take into account the fact that an extended three-year reassessment period exists in respect of reassessments made as a consequence of a transaction involving a taxpayer and a non-resident person with whom the taxpayer does not deal at arm’s length. The Federal Government therefore proposes to provide the CRA with an additional six years to reassess a prior taxation year of a taxpayer, to the extent the reassessment relates to the adjustment of the loss carryback, where:
- a reassessment of a taxation year is made as a consequence of a transaction involving a taxpayer and a non-resident person with whom the taxpayer does not deal at arm’s length;
- the reassessment reduces the taxpayer’s loss for the taxation year that is available for carryback; and
- all or any portion of that loss had in fact been carried back to the prior taxation year.
Sharing of criminal information under tax treaties
The Federal Government has proposed to allow the legal tools available under the Mutual Assistance in Criminal Matters Act to be used with respect to the sharing of criminal tax information under Canada’s tax treaties, tax information and exchange agreements and the Convention on Mutual Administrative Assistance in Tax Matters, in order to facilitate the sharing of information Canada is obligated to share in respect of tax-related offences. These tools include the ability for the Attorney General of Canada to obtain court orders to gather and send information.
Additionally, the Federal Government proposes to enable the sharing of tax information with Canada’s mutual legal assistance partners in respect of non-tax offences that, if committed in Canada, would constitute terrorism, organised crime, money laundering, criminal proceeds or designated substance offences. Budget 2018 proposes to enable confidential information under Part IX of the Excise Tax Act and the Excise Act, 2001, to be disclosed to Canadian police officers in respect of those offences, where such disclosure is currently permitted in respect of taxpayer information under the Tax Act.
Trust reporting requirements
A non-resident trust is required to file an annual (T3) return in certain circumstances, including where the trust has a taxable capital gain or has disposed of taxable Canadian property in the year.
Budget 2018 introduced new requirements aimed at improving the collection of beneficial ownership information with regards to trusts, starting in 2021. The new reporting requirements will apply to non-resident trusts that are currently required to file a T3 return, subject to certain limited exceptions. Where the new reporting requirements apply to a trust, the trust will be required to report the identity of all trustees, beneficiaries and settlors of the trust, as well as the identity of each person who has the ability to exert control over the trust’s assets.
Income splitting and passive investment rules
In World Tax 2018, we noted that the Federal Government introduced proposed legislation aimed at what they described as closing tax loopholes achieved through the use of private corporations. Since the initial proposals, these amendments have been severely scaled back.
In December of 2017, the Federal Government introduced revised legislation in respect of “income splitting” through the use of private corporations, partnerships or trusts. While these rules will only apply to those resident in Canada at the end of the year and non-residents with a parent resident in Canada at any time in the year, persons resident in Canada with children residing outside of the country should consider whether any investments would be subject to tax on split income.
Further, Budget 2018 introduced legislation aimed at reducing the amount of active business income earned by a Canadian controlled-private corporation (CCPC) that is be subject to the preferred small business tax rate. These rules are aimed at imposing measures to limit tax deferral advantages on passive investment income earned inside a private corporation but will have little impact on non-resident investors.
Taxation of cannabis
Budget 2018 proposes a new federal excise duty framework for cannabis products to be introduced as part of the Excise Act, 2001. The duty will generally apply to all products available for legal purchase. Cannabis cultivators and manufacturers will be required to obtain a cannabis licence from the CRA and remit the excise duty, where applicable. The framework will come into effect when cannabis for non-medical purposes becomes available for legal retail sale.
Excise duties will be imposed on federally-licenced producers (cannabis licensees) at the higher of a flat rate applied on the quantity of cannabis contained in a final product and a percentage of the dutiable amount of the product as sold by the producer. The dutiable amount generally represents the portion of the producer’s sales price that does not include the cannabis duties under the Excise Act, 2001.
Sales tax on digital goods
Quebec’s 2018-2019 budget announced the province’s intention to require foreign e-commerce suppliers to collect and remit sales tax on digital services and intangible property sold in the province. Foreign companies selling more than $30,000 annually in such taxable supplies to Quebec customers will be required to register with Revenu Quebec. The measure goes into effect January 1, 2019. Quebec will impose similar measures for Canadian suppliers without a Quebec presence starting in September 1, 2019.
Other provinces and Canada may follow suit, as evidenced by the House of Commons Standing Committee on International Trade’s recommendation for the Federal Government to apply sales tax on tangible and intangible goods that both domestic and foreign companies sell in Canada. The Federal Government is expected to respond to the recommendation this fall at the start of the next House of Commons session.
Treaty developments
Multilateral convention
In World Tax 2018, we noted that Canada signed the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (MLI). On June 20, 2018, a bill was introduced in the House of Commons of Canada to implement the MLI.
Tax treaty update
On December 18, 2017, the Agreement Between Canada and the Cook Islands for the Exchange of Information on Tax Matters entered into force. On June 19, 2017, the Agreement Between Canada and Grenada for the Exchange of Information on Tax Matters entered into force
Canada also entered into a tax information exchange agreement with Antigua and Barbuda, signed November 14, 2017. This agreement is not yet in force.
Jurisprudential developments
Subsequent amendments and the general anti-avoidance rule
The general anti-avoidance rule (GAAR) may be applied in instances where a taxpayer has otherwise complied with the Tax Act on a technical basis but has been found to have abused the its provisions. To apply the GAAR, a textual, contextual and purposive analysis of the provisions in question must be performed. This past year, two decisions were released dealing with the application of the GAAR to tax plans which had since been shut down by the enactment of subsequent legislation. The courts examined how subsequent amendments to the Tax Act can influence a GAAR analysis with respect to provisions in force at the time the avoidance transactions occurred.
As discussed above in the section ‘Statutory Developments’, the Tax Act contains rules that are intended to prevent a non-resident shareholder from entering into transactions to extract, free of tax, a Canadian corporation’s surplus in excess of the PUC of its shares. In the case of Univar Holdco Canada ULC v R, 2017 FCA 207, the Federal Court of Appeal addressed a series of transactions that occurred before the legislation was introduced, and determined that the GAAR did not apply. The decision represented a departure from the Tax Court of Canada’s decision, discussed in World Tax 2017, which found that the series of transactions was abusive, in part relying on the subsequent amendments in reaching this conclusion.
The facts in Univar involved the arm’s length purchase of shares of the parent company of the Univar group. Univar Holdco Canada ULC was incorporated to facilitate a reorganisation that would allow the purchaser to extract the value of a Canadian entity within the group on a tax-free basis (i.e., as a return of capital). This reliance was necessary as the traditional planning mechanism involving the capitalisation of, and purchase by, a Canadian subsidiary of the purchaser was not available in the circumstances.
In overturning the Tax Court’s decision, the Federal Court of Appeal found that the surplus stripping provision restricting an increase in PUC illustrated a “clear dividing line” between an arm’s length sale of shares and a non-arm’s length sale of shares. The purpose of the provision was not to prevent the removal from Canada by an arm’s length purchaser of any surplus accumulated prior to the acquisition, as evidenced by the fact that other plans could be implemented to achieve the same results without offending the provisions of the Tax Act.
In reaching its decision, the Federal Court of Appeal stated that subsequent amendments to legislation do not necessarily reinforce or confirm that transactions that are caught by the amendments would be considered to be abusive before the amendments are enacted. Instead the court looked at the purpose of the provision when it was written and noted that the amendments could not be used to make a finding that the avoidance transaction in question was abusive for the purposes of GAAR.
While Univar appeared to dismiss any reliance on subsequent amendments to legislation in performing a GAAR analysis, the court in Canada v Oxford Properties Group Inc, 2018 FCA 30, offered up further insight. The Federal Court of Appeal, in applying the GAAR to a series of transactions involving a two-tiered partnership structure used to avoid taxable capital gains on underlying real estate transferred to the partnerships, found that a subsequent amendment could be used to determine the purpose of prior law but it must first be determined whether the amendment alters or clarifies it.
The court in Oxford found that a subsequent amendment to a “bump” rule, which permitted an increase in the adjusted cost base of a partnership interest held by the taxpayer, conveyed a rationale that was already present in the provisions in force at the time of the impugned transactions. As such, the court found that the use of the tiered partnership structure to bypass the distinctive treatment of depreciable property, i.e. the underlying real estate initially transferred to the partnership, frustrated the reasons for the initial provisions. The subsequent amendments in this instance were determined not to operate as new law but simply had the practical effect that the GAAR would no longer have to be resorted to in order to prevent the achieved result.
The Federal Court of Appeal did however note that it reached its conclusion without placing any emphasis on Budget Supplementary Information released by the Federal Government in conjunction with the new provision. These types of publications, the court noted, may be self-serving, particularly in a GAAR context where the pre-amendment law is in issue, and should therefore be disregarded.
Common Interest Privilege
In World Tax 2018, we discussed the Federal Court of Canada’s decision in The Minister of National Revenue v Iggillis, 2016 FC 1352, which examined what is referred to as common interest privilege in the context of a commercial transaction. The doctrine of common interest privilege, while not a separate type of privilege itself, is often recognised by Canadian courts as an exception to waiver of solicitor-client privilege where privileged communications are shared with unaffiliated parties with the common interest of completing a transaction.
In last year’s Federal Court decision, the court departed from precedent in finding that a legal memorandum addressing the tax consequences arising from a series of commercial transactions, prepared by counsel of a party with whom the taxpayer had dealings, was not protected by solicitor-client privilege and was therefore required to be disclosed to the CRA pursuant to a requirement for information. The memorandum had been shared with the taxpayer as it was necessary for both parties to understand the structuring discussed therein to complete a deal.
However, the Federal Court of Appeal disagreed with the Federal Court’s conclusion and found that the memorandum was protected by solicitor-client privilege and this privilege was not waived when it was shared with the taxpayer. This determination was made based on an examination of the relevant provincial superior court jurisprudence (in this instance Alberta and British Columbia), which suggested that solicitor-client privilege is not waived when an opinion provided by a lawyer to one party is disclosed, on a confidential basis, to other parties with sufficient common interest in the same transactions. The court found that the sharing of such opinions in the context of complex statutes such as the Tax Act may lead to efficiencies in completing the transactions and better service to the clients. This is a welcome decision for clients and lawyers acting together to implement transactions in a tax effective manner.
CRA Requirements
The Tax Act provides the CRA with a broad scope of investigative powers to request information from both the taxpayer and third parties. While the courts limited the scope of these powers to some extent this past year in Iggillis, above, other decisions in the past year examined the extent of the CRA’s ability to request information in situations where documents included unnamed third parties or information potentially obtained illegally.
In Canada (National Revenue) v Paypal Canada Co, [2017] GSTC 93 (Federal Court), the court granted an application in favour of the CRA to impose on Paypal a requirement to disclose account holder information of corporations and individuals holding business accounts, including the total number and value of transactions made by these account holders. The court, in justifying the requirement, noted that the group of persons was ascertainable, despite its size, and the application was brought in furtherance of an audit undertaken to combat the underground economy.
In Canada (National Revenue) v Stonkovic, 2018 FC 462, the court found that the CRA may issue a requirement to a taxpayer even if such requirement was issued based on information obtained illegally. Pursuant to the tax treaty between Canada and France, French authorities provided information pertaining to Canadian residents included on the “Falciani List”, a list obtained from an HSBC employee who had copied the list, to the CRA. The court agreed with the CRA that Canadian Charter rights did not prevent the CRA from relying on the information in issuing its requirement; charter rights apply only to state actors and not to the gathering of information outside of Canada where the authorities involved were not acting on behalf of any of the governments of Canada.
Voluntary Disclosure Programme
This past year saw major changes to the CRA’s voluntary disclosure programme (VDP), a mechanism that allows taxpayers to correct previous non-compliance with Canadian tax laws with the benefit of relief from criminal prosecution and penalties, as well reduced interest on taxes owing. While the requirements for an application under the VDP were previously quite straightforward, that the disclosure be voluntary, complete and relate to a taxation year that is at least one year past due, the CRA has developed the programme into two tracks, offering a more limited programme in instances where there is an element of intentional conduct, such as an effort to avoid detection through the use of offshore vehicles. Generally, applications by corporations with gross revenue in excess of $250 million in at least two of their last five taxation years, and any related entities, will be considered under the limited programme on a going-forward basis. A taxpayer will still be able to obtain relief from criminal prosecution and gross negligence penalties if an application is accepted under the limited programme, although other penalties may be applied and no interest relief will be provided.
The CRA has also begun to further pursue those taxpayers whose applications have been accepted under the VDP. In Gauthier v Canada, 2017 FC 1173, the Federal Court of Canada dismissed the taxpayer’s application for an injunction to prevent the CRA from reassessing statute-barred years prior to those disclosed in his VDP application. The taxpayer had received relief in respect of his 2005 through 2014 taxation years, but the CRA sought to audit his 1980 through 2004 taxation years (the taxpayer could not apply for relief for these taxation years as a VDP application was limited to the previous ten years).
While the court found that the taxpayer had not provided enough evidence in support of an inunction, in particular that the issue of a reassessment in and of itself would cause him irreparable harm, it did not comment on whether such a reassessment would be valid. Regardless, the fact that the CRA will attempt to audit and assess based on information provided through a VDP application may deter non-compliant taxpayers from coming forward in the future.
Other Decisions of Note
- In World Tax 2018 we discussed the Tax Court of Canada’s decision in Rio Tinto Alcan Inc v The Queen, 2016 TCC 172, with regards to the deductibility of investment banking fees paid for services rendered to assist board members in deciding whether to approve proposed transactions. This past year the Federal Court of Appeal confirmed the Tax Court’s decision (2018 FCA 124) to distinguish between “oversight expenses”, related to professional services rendered to the board in the oversight and decision-making process, and “execution costs”, related to the actual implementation of the approved transactions, allowing a deduction for the former as current expenses and considering the latter as capital expenditures, added to the cost of acquired property.
- In Groscki v The Queen, 2017 TCC 249, the Tax Court of Canada applied a narrow interpretation to the term “legal representative” in determining that a director of a corporation, acting in that role, was not liable for an unpaid tax liability of the corporation. The court found that the Tax Act required a dissolution or liquidation of the corporation, which did not occur in this instance, and even if that were the case, the director must have been acting as a liquidator, receiver of any kind or other like person in order for the CRA to assess the director for the unpaid taxes of the corporation.
- In CIBC World Markets Inc v The Queen, 2018 TCC 103, the Tax Court of Canada disallowed input tax credits (ITCs) under the Excise Tax Act in respect of services supplied by the taxpayer, a Canadian resident financial services corporation, to non-resident branches of CIBC. The court found that a s.150 election under the Excise Tax Act to deem all supplies between closely related entities of a financial institution as financial services and therefore exempt supplies, prevented CIBC World Markets from claiming ITCs in respect of services to the non-residents branches (zero-rated supplies).
- The Tax Court of Canada released an interesting informal decision regarding the deduction of interest in the case of Van Steenis v R, 2018 TCC 78. The court found that the amount of interest that was deductible in respect of loans used to purchase units of a mutual fund was reduced by returns of capital received in respect of the units that were subsequently used for personal purposes. The decision, while not binding, is reflective of CRA guidance on the return of capital.