Professional Documents
Culture Documents
ITA ANSWERS...................................................................................................................................................................2
1. Part XIII - Withholding Tax...................................................................................................................................................2
2. Part I - Income Tax................................................................................................................................................................ 2
RESIDENCE........................................................................................................................................................................2
R. v. Gurds............................................................................................................................................................................... 2
Types of payments.......................................................................................................................................................13
s. 212 (a) Management fees.....................................................................................................................................................13
s. 212(1)(b) - Interest............................................................................................................................................................... 14
s. 212(1)(c) - Estate of Trust Income.......................................................................................................................................14
s. 212(1)(d) - Rent, Royalties, etc............................................................................................................................................14
212(2) - Dividends.................................................................................................................................................................. 14
s. 212.1 - Anti-avoidance rule against surplus stripping.......................................................................................................15
3 POSSIBLE SYSTEMS......................................................................................................................................................19
126(7) - non-business income tax defn....................................................................................................................................19
PAPER REMARKS.............................................................................................................................................................21
CH. 8 - F.A.P.I. (SS. 90-95)...............................................................................................................................................22
Purpose................................................................................................................................................................................... 22
Levels of FAPI taxation:.......................................................................................................................................................... 22
1. Non Foreign Affiliate..........................................................................................................................................................22
2. Foreign Affiliate.................................................................................................................................................................. 22
3. Controlled Foreign Affiliate................................................................................................................................................23
91(1) Amounts included from FA............................................................................................................................................23
NOTE ON IBC..................................................................................................................................................................25
ANALYSIS...................................................................................................................................................................25
DEFINITIONS - 5907(1)....................................................................................................................................................26
94.1.............................................................................................................................................................................27
CH. 10 - FOREIGN AFFILIATE SHARE EXCHANGE & MERGERS....................................................................28
Domestic Transactions............................................................................................................................................................28
FA Transactions....................................................................................................................................................................... 28
S.
85.1(3).........................................................................................................................................................................28
95(2)(C)...........................................................................................................................................................................29
95(2)(D) - FOREIGN MERGER...........................................................................................................................................30
CH. 11 - OFFSHORE TRUSTS.......................................................................................................................................31
94(1) - re offshore trusts..........................................................................................................................................................31
Held:...........................................................................................................................................................................35
3) Nadeau................................................................................................................................................................................ 35
Note to Reader:
What follows are unedited class notes. Beware of possible errors Ive been known to make a few!
Other Sources:
Stikeman Bulletins
Matthew Bender
Tax Journals
C:
US - by Citizenship
Tax the indiv or the corp? If tax per control, what if its split btw 3 countries?
3
s. 212 - 25% tax on non-residents for passive income paid by Canadian resident
Tax treaties
2. Part I - Income Tax
s. 2 - how R & NR are taxed & on what
Proposed amendment, 1998: Where a family ceases to be factually R in Cda (factually, common law rules;
outside s. 251), the spouse of a person under (b), (c), (d), (d.1) will only be treated as a R if not taxed in
new country because of a tax treaty. Point: if already taxed, Cda will not also tax.
(f) Child..
250(4) Deemed R for corps where
(a) Incorporated in Cda after April 26, 1965
See R. v. Gurds
Per notes to s. 250(4), CL test must be considered in addition to this subsection
R. v. Gurds
4
Make sure the co. is not carrying on business in Cda in the process
Look at:
1. What does it mean to Carry on business in Canada?
Purpose: Prevents Cdn R from setting up a controlled foreign affiliate (CFA) to earn interest income.
Residence - Continuation
International or interprov continuation: law changed & now deemed to have been incorporate on the date of
continuation
Special Rules on Residence
1. 250(6) - Intl Shipping Company
Goal: attract Hong Kong residents to Cda by exempting intl shipping revenues from taxation (but taxed on other
income, was thus ineffective)
2. Cdn Co owns US co with 5 Cdn Directors
See notes
3. Trusts
FAPI rules extend to trusts however, thus NR doesnt mean not taxed
4. s. 114 - when become a resident part way through the year
Point: Rules to determine who is R and NR. Other rules to determine who is taxable & who is not.
Friday, January 15
Sources
1. ITA
2. Income Conventions Interpretations Acts
3. Treaties (modeled on OECD or UN conventions)
Each treaty overrides the ITA, providing the opportunity for overlap. Does an extended definition of interest
under the ITA apply to the treaty as well? What if the ITA is amended after the treaty is passed.
Residents
Non-Residents
5
c.g.
foreign income
direct
Residents
Individual
1. Common law rule
- Persons presence
Corporation
Trust
2. Deemed Residence
- 183 days
- Govt. employee
- Formed in Canada
- na
- 94(1)(c): taxation of NR trusts
Scenario A: Trust with trustee of Isle of Man Co., which has 4 Directors from 4 different countries. May meet by phone.
Where is the trust resident?
Scenario B: Canadian wants to move to the U.S. Becoming a NR to Canada = departure tax. If 7 months in U.S. but
has not severed ties in Canada, remain a resident in Canada
See Canada-US tax treaty (p. 2604), Art IV; Tie-breaker rules at par. 2: where is the TPs centre of vital interests
Thus deemed resident in US for purposes of the treaty but still R of Canada under the ITA (ie: departure tax still
doesnt apply)
If TP wants to sell shares, what are the tax consequences? Art. XIII:4 (p. 2636): Starting point: dual resident,
deemed US resident for purposes of the treaty. XIII:4 says he will be taxed only in the US.
Based on this simple reasoning, could have a huge Canadian gain, move to the US & thus not pay tax. The
thinking was that there would be tax upon sale, not upon departure (preserve the right to tax for 5 years - the
US can tax instead). Rev. Canada. proposed an amendment at s. 250 (see text - grey box) that deems TP to be
NR for purposes of the ITA. Therefore, departure tax arises.
(Critical of Bronfman issue, which was legitimate & departure taxes generally, which arent seen outside
Canada & Australia. B. used s. 107)
2(3)(a) - tax on NR
115(1)(a)(i)
Inclusions: ss. 6
7(1) - stock options, when exercised will generally be included in income
Hale
Stock options
eg: 1000 @ $40:
leaves Canada in 1986, exercises options in 1987 (worth 60) = gain of $20,000
Stock option plan: 7(1)(a) - value less cost of the shares is deemed to have been received when shares are acquired.
But in our case, the value accrued after leaving Canada.
Court
7(1)(b)(4) & 115(1)(a) cant apply - inconsistent with 3(2) & 15(1) of the Convention
TP is arguing that he wasnt employed in Canada in the previous year & that the Conv trumps the ITA, thus 2(3)
ITA na
Hurd & Hale - same fact pattern. Ct ruled both subject to Canadian tax.
New facts: NR deriving income outside Canada = no tax. Gets options & exercised before returning to Canada =
also no tax.
If exercised after his return to Canada, will be taxable on the full accrued amount (empl income taxed upon
receipt).
Hewitt
Employed in Libya & made contributions to a company plan. Upon leaving in 84, informed co. to pay to a
location he would indicate later.
Upon return to Canada, tell co. to deposit to his Canadian bank account
Equitable decision in favour of TP but effect is to reverse Hale. This ruling is out of left field.
Friday, January 22
Me. Guy Mason:
Ch. 3: Non-Residents with Canadian Business Operation
3 ways to do business in Canada:
1. Through a distributor
Birmount Holdings held that if an isolated transaction is consistent with a companys only business, the
Tara ratio will not apply & it will constitute carrying on a business
Canadian Marconi
81(1)(c) - Exemption for International Traffic (p. 26-27)
Income from the operation of a non-resident ship or aircraft will be exempt if that country grants similar
relief to Canadians
Furness, Withy: In this case, the company was a shipping agent for an English company but held to be
taxable since the agent was not working on one of their own ships. Servicing on own ships is tax exempt,
but not work done for Canadian corporations.
Extended meaning of carrying on a business in Canada
s. 253
Sudden Valley: Washington land company placed ads in Canada. Held by Rev. Canada to be taxable but
court viewed as merely an invitation to treat. Offer only made once Canadians went to Washington. On a
more practical level: the land & transaction was in the U.S. - no justification to impose Canadian taxes.
Case is relevant for current issue of Internet invitations to treat, where browsers are invited to buy
real estate in another country (as opposed to on-line transactions for merchandise).
Distinction between Capital & Income (p. 28)
253(c)
Need a permanent establishment to benefit from them: per XI(5) of the Canada-US treaty, it must be
attributable & effectively connected with a permanent establishment
Under the UK treaty, must be a UK enterprise to benefit from treaty protection. If the UK business in
unrelated to Canadian business, not protected. (Old way of doing things with the US: if didnt have an
similar enterprise active in the US, did not benefit from treaty protection.)
NR buying & selling real estate in Canada through an agent over years
Rev. Canada considers the PLACE where: contract formed; profits arise; delivery; bank accounts; payment;
manufactured; orders solicited; inventory kept; agents i.e.: fact-based
Other tests (p. 31)
Belfour - Italian silk merchant selling in the UK through an agent. Held that business was carried on in the UK
even though contract made outside the UK. Look at where payment is made, work done, delivery, etc.
Services - test of performance
Prof. feels that case is substantively right: there was no fixed base
However, at some point we need to clarify the difference between fixed base & permanent establishment
2. Cudd Pressure Control [1998] F.C.A.
U.S. enterprise charging themselves a notional rent. Company looked at the cost of rent of a (non-depreciable)
machine to third party & charged themselves.
Prof. cant believe it went to FCA - doesnt agree that there could be situations where you may charge yourself a
notional rent.
Partnership
Entreprise Blaton-Aubert [1972] C.T.C. - joint venture with a Canadian company to build an Expo 67 pavillion.
Not a partnership per se but court nonetheless held them to be carrying on a business
Use of agents (32)
9
Distributorship
Firestone: US company did world-wide marketing but UK subsidiary did manufacturing. Distributor sold tires in
Canada and placed orders with the U.S. U.S. parent deemed to be carrying on business in UK via their
manufacturing agent.
US citizen made loans in Canada through a loan broker. Held that the broker was not an agent since he had no
power to bind Pullman. Discretion on involvement with opportunities was entirely in the U.S. (Even though
multiple loans made.)
Carrying on a Business Cases
1. Gurds [1985] F.C.A.
Shows that even though you can formulate an opinion based on available considerations, can still get caught as
carrying on a business in Canada. Tax is not an exact science.
2. Capital Life Insurance [1986] F.C.A.
US life insurance company had only 5 contracts. Essentially only dealing with themselves although eventually
wanted to branch out.
Loss carry forward: better to have a branch if losses are certain since these losses can be carried forward (p. 35)
Quebec is bound by federal treaties. Ontario has a somewhat different head office rule.
Investment allowance
p. 38 Incorporation of a branch
s. 85 rollover of assets
under 219(1)(l), can have a forward strip. Select a low PUC and avoid immediate tax.
233.1 - must file annual info forms
V. NR Utilizing a Canadian Subsidiary (p. 39)
Thin capitalization
Similarly, s. 17: if a reasonable rate of interest is not charged to a NR, will be deemed to have charged a
reasonable rent. s. 17 revisions underway to limit avoidance.
Indalex Ltd.
80.4(2) - Interest free shareholder loans = deemed benefit
Inter-company pricing. s. 69(2) & (3) repealed & replaced by s. 247 (part XVI.1)
Friday, January 29
I. Resident
World income
Concept of residence / NR
Deemed R & NR (Common law & ITA / individuals, corps & trusts)
II. Non-Resident
1) Part I (tax on income)
royalties, dividends
3) Part XIV - Branch Tax
Can Co. earnings = 100; less 40 tax (Pt I) = Net 60 paid as dividends, 5% div. tax (Pt XIII) = 57 net to US
Co.
Branch earnings of 100; less 40 tax (Pt I) = Net 60 U.S. company pays a dividend, thus not caught by Pt
XIII [Pd by Canadian to a foreign entity]
Branch tax (219.1 or .2?) usually yields the same result. Tax of 25% but is reduced to the treaty rate, which is
5%. Branch tax paid when money taken out of Canada (via an investment allowance).
$500,000 exemption
11
Personal use
Passive investment
Rentals
Property / Business
Gains
Capital / Income
Relevance
Passive = Gains
Active = Income
Part XIII
Part I
Gains
At one time, most countries did not tax gains. Led to jurisprudence on income or gains
Adventures = income
Characterization
Scenario: Bill Gates wants to buy property in Muskoka; a 2nd via a Canadian corp; a 3rd via a US corp; a 4th via a
chain (USCo owns Canco that has a property)
BG personally:
Speculative
Provision added in 1991 because of land-flipping in Hong Kong that was not caught under 2(3)(c)
[CG] nor was it clearly caught under 2(3)(b) [income from carrying on business].
2.
What is he sells Canco? Shares of a private R corp.are taxable Canadian property [s. 115(1)(b)].
Can-US treaty 10 & 13. 10:2(b) = 15% CG: 13(3)(ii) = capital gains on shares held in real property ARE
taxable in Canada
3.
BG via a US Corp:
US Corp = Taxed on CG // If income caught by 2(3) & 253 and branch tax
Net effect of 2 & 3 should be the same, whether its treated as income or CG
Even with CG, branch tax may be on the full amount, not ? (see s.219)
4.
people now setting up a Canco to buy condo so when they die, they are not holding US property
Treaty provisions designed to stop this: stop estate tax on most individuals, but the wealthiest. Problem:
mortgage = taxable benefit for those using Canco
Reverse situation: BG USCo Muskoka. If BG dies, wont pay tax. 2-3 years ago, shares were deemed to
be taxable Canadian property (where shares in NR co. which derives most income from real estate Point:
new provision to target the above situation but it affects many other transactions. US didnt like it thus forced
to exempt the Americans (4th Protocol)
End result: BG sells shares in USCo = exempt / But taxable in any other country!!
Net effect of 2 & 3 should be the same, whether its treated as income or CG
Trust
800,000
100,000
750,000
- 50,000
Issues:
1. Is the interest of the beneficiaries in the trust taxable Canadian property
s. 115(1)(b)(11): Caught by the extended defn of taxable Canadian property: must be 50% or more
if: Uncle BVH Co HK Co Trust
Each level of shares are taxable Canadian property; pay tax at each level
* But, secondary withholding tax under 212(13.2): where NR business carried on principally in Canada
3.
4.
To be sure (protect yourself), s. 216 allows you to file an election deeming you to be carrying on a business
5.
6.
7.
8.
If everything sold & $1M gain realized, is it taxable in the hands of the trust?
9.
But, has their been a disposition of the trusts interests? (We wont look at this)
Friday, February 5
Mintz Committee
Martin distanced himself from many of the recommendations (lower corp. tax, fewer subsidies, etc.)
14
R NR
Exceptionally: NR NR
Not R R
Rate
Exceptions
Government debt
Corporate debt
As an administrative practice, Revenue expects payment on the 15th of the following month
Here, payment made Jan. 17th, mailed cheque Feb. 14th but not received until Feb. 20th
Must differentiate between different types of income: CG, business income, dividends
s. 212 (a) Management fees
212(4)(a) - eg: Fee of $100,000 paid to Bain & Co. in the U.S. Per s. 212(4)(a) defn of management fee, this is
not caught by the ITAs narrow definition.
Would we have to withhold under Reg. 105? (Withholding on account of tax: hold now then figure out if
any tax is owing.) NO
Revenue wants intl companies to allocate their time & revenue by country and show that its reasonable.
1.
2.
3.
4.
5.
If US parent is in a loss position & Canco making a profit, can save the whole 45% tax on the amount
transferred
Will be treated as a deemed dividend under s.15(1). Per s. 214(3), this will be treated as a deemed payment
(thus subject to withholding taxes).
Much money to be made in transfer pricing (raw materials, manufacturing, etc.) but most large companies
dont want to get caught doing something wrong & thus play by the book. More evasion among small
businesses, owned by managers.
Steps
1.
2.
3.
4.
5.
Competent authority rules under the Treaty settles those cases where the two countries do not agree
s. 212(1)(b) - Interest
Exceptions to inclusions
Rents: 25% of real estate doesnt make sense. Under s. 216, will elect to be taxed on the net basis. But if
rental income in part on carrying on a business in Canada, caught under Part I, not Part XIII (Reg. 805: no Part
13 tax where part of business carried on in Canada.) Carrying on a business includes staff required to run
an office building.
212(2) - Dividends
The amount by which the payment exceeds PUC is assimilated into a dividend
Problem: withholding tax on dividends as it tries to extract the value from Canco
To get around this, create Acquisition Co, inject 50,000 (high PUC) then merger it with Canco to get money
out tax free
Compare:
a) US Co owns Can Co
ACB / Cost 50,000
PUC
10,000
FMV
50,000
b) US Co owns Acq. Co
ACB / Cost 50,000
PUC
50,000
FMV
50,000
Canada-US Treaty
5% withholding on dividends
NR owns
Stock in Bell yields 100 CG - not TCP thus no tax; 25% withholding, reduced by treaty
Private company stock yields TCG (CG) - TCP; 25% withholding, reduced by treaty
Interest on bank account yields interest - 25% withholding but issue a T5, reduced by treaty
Assume each yields an income of 100 for the investor =400
Normal Canadian co doesnt make sense = tax burden (e.g.: Can Co = taxed domestically then subject to
withholding as well)
NRO allows an NR to Canadian assets or investments and achieve about the same results as if they were held
directly
17
90 day election period from the day the company starts its business
133(8) - Defn: no more than 10% of revenue from rent; principle business not making loans
No deduction of interest
Otherwise, Bombardier interest on bonds would have been exempt but the Can Co would have been taxed
at (?). Thus, not a perfect mechanism.
But: Year 2 - when a dividend is paid out, the NRO gets a refund (full $75) but the NR pays 25% on
dividend, less treaty reductions.
[Like the Canadian investment co.; tax the investment co. holdings until dividends pd, to prevent
deferrals.]
Scenario: Receiving royalties in Bahamas from various companies, at a rate of 25% withholding. If interpose a
Canadian NRO, reduced by treaty to 10%. Dividends then paid by NRO to Bah. (but subject to 25%
withholding!?)
Somehow, NROs were used to reduce foreign taxes (he cant remember how)
NROs no longer benefit from Canadian treaties - Made Canada ~ tax haven
Structure eliminated by the 3rd Protocol in 1995 by raising withholding to 15%, thus matching the 15% that
would be withheld if the Can Co paid US directly (Note: Until 95, US Treaty re interest was 15%, not 10% as
it is now.)
18
Treaty?
2. 10% maximum in the country where interest arises. But interest not arising in Canada thus not
applicable.
7. As a general rule, interest arises where the payer resides. However, where the person paying the interest
has a PE in the other country, which bears the interest, it shall be deemed to have arised in the UK. Break
at 11(2) thus n/a (Still at 25% since still R NR)
1. If items of income are not dealt with elsewhere, it will only be taxed in the other country unless it arises
in Canada. [Since Art. XI did not deal with the interest payment at issue, would look to such a provision.
Unfortunately, the UK Treaty does not have an Other Income clause.]
Conclusion: would only be taxable in the UK = 0 WT if under US Treaty. [The argument to be made is
that Art. 11 of UK treaty does not encompass this situation & thus is not dealt with.]
What to do in UK? 25% with a treaty partner just because borrowed in Canadian dollars? Ans: write for a
technical interpretation, given that there is no policy rationale for the apparent outcome. Rev. Can. responded
that per Art. 11(2) Canada can only tax at 10%. If outside scope = 0% (like the 212(1)(b)(ii)(E) exception)
9,000 - Interest
Setlawke was always concerned that Rev. Can. would say that the loan is effectively secured (lookthrough).
Art, XI(1) - Payer must be R of Canada; 212(13)(f) deems the Singapore indiv. to be a R for this purpose.
Doesnt make you a R of Canada for purposes of the treaty!!
If not a R, then payment does not arise in Canada, as required under (1) of the treaty
Setl: Better view - (13)(f) probably wont apply but if it did, payment not deemed to have arised in Canada under treaty
- despite deemed R per ITA * Read treaty defn of R.
Argue then, that XI(2) is all-inclusive & that Canada can only apply when it arises in Canada
212(1)(b)(vii) - 5-25 Rule: Cant be obliged to pay more than 25% of the principle with 5 years
Also okay where the payback is triggered with a change to the legislation, change in control
Closing par. of (1)(b) - deduction n/a if its a participating loan (ie: interest is calculated as a percent of
revenue, or value)
20
Friday, February 19
Chapter VII: Canadians doing business abroad - Foreign Tax Credit
126(1) - Non-business income tax
126(2) - Business income tax
e.g.: RRSP invested in Alcan = Canadian dividends. If in Alcoa (US), 15% US withholding on dividends. No
credit here since not paying Canadian tax on an RRSP.
126(1) - If invest as an individual in
But include the entire 100 when computing world income, less 53% tax.
DTC to offset: Pay 15 to US, owe 53 to Canada less 15 already paid = 38 in Canada.
Above is the system for non-business income tax (NBIT): 126(1). But the results are the same for
corporations:
126(2) - Canco with a UK branch that earns a profit of 100
UK tax of 40% = 60
e.g.: s. 126(1)-(2)
2.
Exemption system
What happens when you instead have a company? Not taxable in Canada since not R but pays a
dividend to Canco
100 less 40% tax = 100 - 40 = 60
UK WT of 10% = 60 - 6 = 54
The money received as a dividend from UK Co is not business income tax but rather a non-business
income tax
126(1) - FT deduction
- TP equity not less than 1% and total equity of TP & related not less than 10%.
Reason: 113(1) FAPI rules provide an exemption (eliminates the need for a credit). Essentially,
allows Canadian Cos to carry on business through a corporation that will pay taxes in that country &
Canadian taxes on dividends.
i.e.: ACB earned by an affiliate in a treaty country will already be taxed appropriately in that
jurisdiction & wont tax again.
s. 20(11)
Section 17 - Loan to NR
Where corp. R in Canada made loan to NR and was outstanding 1 year or more without interest, the corp. will be
deemed to have received interest at the prescribed rate
1)
US
|
Canco
|
| NR loan
|
Belgium loan to Canco
2)
17(3)
If a subsidiary controlled corp. [248(1)] & money used in the business, its okay
If there was a B Co owned by Belgium Co, 17(1) WOULD apply as a 2nd tier sub not caught by definition
US
|
Canco
|
| Sale of property
|
Belgium
3)
Looks like a loan from Canco to US Co; which is a deemed dividend [15(2) shareholder benefit & 214 deemed
dividend = 5% WT]
Loan by a Canadian corporation
Rev Canada may decide not to pursue under 17 where 13 has applied instead (WT)
Setlawke Structure:
US Co -----------------------|
|
22
US Co owns
100% Canco
100% Norway Co
50% Belgian Co
Canco owns 50% Belgian Co
Belgian Co has 10M in income
Assume FAPI n/a to US COs holdings of B Co
Concern: 17(1) as modified could affect situation by attributing the loan to Canco
Transfer Pricing - example 1
How to justify? Expenses and other work required in Canada may be higher whereas could US Co may be doing
the work internally.
Usually ends up in the hands of economists to assess and corps. will eventually come to a settlement with
Revenue Canada.
Point: is income being shifted between companies? What is a fair price? thats the issue in transfer pricing.
Transfer Pricing - example 2
May have paid $8 for the ingredient but what can the company charge as an equivalent to an AL royalty? (etc.)
Conclusion:
At the end of the day, the issue is what would an AL party have paid?
Soujourning rule applies where present in Canada, not residing. If Rising Star resides in Canada as of June 1, he is
not subject to soujourning rule; rather, he is resident in Canada.
23
Taxation of passive income earned by foreign corporations. Goal is to avoid setting up foreign companies to earn
passive income. Otherwise, could have indefinite tax deferral.
1. X earns $100 in CIBC or $100 in Swiss bank: Canadian resident individual is taxed on world income thus,
no difference in tax treatment.
2. X owns Canco that earns $100: Same result
3. X owns Bahamian company that earns $100: Want the same results here to achieve neutrality.
Anti-deferral / attribution regimes used all over the world to prevent such blatant avoidance techniques.
What about active business income?
Canadian government wants to encourage Canadian business to operate in other companies on the same footing as
their competitors in that jurisdiction.
Inter-affiliate dividends?
Can Co
|
Bahamian Holdco
/
\
US Opco
UK Opco
1.
2.
3.
4.
\
Berm Co (non-treaty co.)
Exempt Surplus: ABI earned by a co resident & carrying on business in a treaty country. (Dont want
to subject US Co & UK Co to operational taxes above what is paid in those countries.)
Taxable Surplus: Includes ABI earned by a foreign affiliate that is either resident or COB in a nontreaty country. (Berm Co not subject to taxes; thus taxable once money brought back to Canada. Rate
= difference between Canadian & Berm rates.)
NOTE: Inter-affiliate here is referring to FOREIGN affiliates. Thus Bah Can Co not included.
Where Can Co is paid a dividend, it is subject to taxation BUT relief from double taxation under s. 91(5) for
previously taxed FAPI.
91(4) also grants relief to the extent FAPI paid a foreign tax
Levels of FAPI taxation:
1.
2.
3.
24
FAPI only applies here: (1) need to cut it off somewhere and (2) this is where TP can easily influence affiliates
behaviour.
91(1) Amounts included from FA
Can Co
|
B Co3
|
B Co4
Value of 51% of B Co3 share includes value of B Co4
1. 95(1) defn of FA
NR corporation in which:
(a) TP holds 1% or more
(b) Total in excess of 10% (directly & via related persons)
Controlled by
(a) TP
(b) TP & no more than 4 other Canadian residents
Arnold Steinberg
/
Jersey
Effect: if principle reason was to avoid tax, will be assigned a notional income, regardless whether a payment was
made.
3. 95(1) defn of FAPI
(A + A.1 + A.2 + B + C) - (D + E + F + G)
where:
A: FAs income for the year, other than CBI
B: Taxable CG, accrued after 1975 (since FAPI rules introduced in 76)
D: Losses
25
ie: FAPI is income from property (other than ABI) and CG less losses
95(1) Defn of active business of a FA
s. 125 case law of what is an active business has been very generous with towards TP (low threshold)
/
MS
X
|
CFA
|
10M
|
|
SB
\
G
Thus AB here excluded investment businesses like the above to ensure its caught by FAPI
a)
Real FAPI
b) Deemed FAPI
e.g.: Setlakwe
|
Bah Co Payment for sevices
95(2)(b) - Where Bah Co provides services but services are performed by a person resident in Canada (X), will be
deemed FAPI
c)
Deemed ABI
Can Co
/
\
US LLC 10M loan US Opco
US Opco = ABI
US Opco pays interest to US LLC
US LLC is a single purpose company: it earns interest
Without the payment, would have a higher ABI which is not FAPI, thus why would this be FAPI?
Thus, the payment is deemed not to be FAPI; deemed ABI to US LLC as well
Key element to the way that Canadian companies finance their operations. Called a double-dip structure.
Friday, March 19
26
investment business defn: to overcome the low threshold the courts have found to qualify as ABI
s. 95(2) - deemed FAPI, deemed ABI
s. 113 - deductions for dividends: exempt surplus (exemption), taxable surplus (credit), preacquisition?
Passive income
(1) exempt surplus - ABI of a foreign affiliate COB, resident in a treaty country
(2) taxable surplus - Taxed in Canada but relief given for foreign tax paid
Regulations
5900 ff.
But Barbados IBC provisions are for companies not owned by residents of Barbados (that is not operating in Bb?)
Example
CanCo
|
100%________|________100%
|
|
LLC (US) -loan
US Co
Interest inc. 5M
|
______|_________
|
|
100,000,000
- ABI of 10M
portfolio
- Tax of 4M
- 8M income
- Net = 6M
- 3M tax
- Net = 5M
ANALYSIS
1) The 2 US companies CFAs
2) ABI is not attributed on a current basis (Canada taxes residents & FAPI; this ABI income is neither)
3) 6M net goes into exempt surplus:
Reg. 5907(11) [see list of countries in Green Act fine print] - countries on this list are exempt surplus (in
principle, these should all be treaty countries). New Regs. at 5907(11) eliminates the list and replaces it with
notion that a designated treaty country is one that has a comprehensive treaty with Canada.
Reg. 5907(11.2) FA deemed not to be a resident in that country UNLESS (a) it is resident of the country for
purposes of the treaty [ie: US Co, taxable in the US, is resident of the US - a treaty county].
Barbados Treaty
1. IBC owns Canadian payments to IBC subject to 25% withholding tax
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Definitions - 5907(1)
Earnings from a FA is ABI before tax computed under US law = 10M above
Net earnings from a FA is the amount of earnings from AB less taxes = 6M above
Exempt earnings is the total of all amounts each of which is (d) after 76 & is R of a designated treaty
country. = 6M
see 95(1) defn of active business: other than investment business / if 10 people are managing it, could it be
an active business? Perhaps, but then is it an investment business
95(1) defn of income from an active business: includes any income incident to that business
Thus, 1st ask if it is purely passive income. If so, its FAPI. If not, is it ACI (incidental or not)?
If we assume that it is not incidental business income & not property income per se since there are 6 people
managing this portfolio.
Is it an investment business? Defn at 95(1) - IB where principal purpose is to derive income from
property, UNLESS it is established that the business is (a)(i) the lending of money or and (B) 5 or more
full time employees
Could buying bonds be considered lending money? If can fall in here, not an investment business.
Therefore, ABI & escapes FAPI rules.
5907(11.2) says that despite the fact it is called a P in the US, Canada treats it as a corporation.
95(2)(a)(ii) - in computing income from an active business, shall include (deeming) amounts related to an
active business [in U.S., making 6M ABI from US Co + 5M from LLC] the whole amount in the US is used in
one active business (since money is loaned to US Co). If the 5M were FAPI, it would only compel a merger of
the 2 US companies in order to become exempt.
If the interest income earned is from LLC is due to the loan to US Co employed to earn ABI, the interest
expense is deducted from US Cos income and treated in hands of LLC as ABI. [see s. 95(2)(a)(ii)]
See defn of earnings at Reg. 5907, par.(b): Relevant since US Cos interest expense is deductible
Ans: 1st Deemed ABI under 95(2)(a)(i) - 2nd look to Regs which says that you include the amount in earnings
(income);
Since LLC is a flow-through entity, US with withhold 10% of interest payment by US Co to LLC
CanCo
|
CFA
ACB = 100
FMV = 175
1. If sell, results in a c.g. of 75
2. What if CFA gives a div. to CanCo? = Tax-free inter-corporate dividend & FMV decreases by 75.
3. If it doesnt 93(1) allows the 75 of the 175 to be deemed a dividend
CanCo
|
USCo1
| (60)
USCo2
Dividend: USCo2 USCo1 of 60 from one exempt surplus account to the others exempt surplus account
What if sell USCo2?
Excluded property means active business assets - not part of FAPI. Thus exclude shares of foreign
affiliates that are active businesses
94.1
CanCo
_|_____________________________
CP
Trimark MF
Casurina fund (T-Bills)
C. fund was a tax avoidance (deferral) mechanism; no dividends but large c.g.
later on. If held 3%, not a FA or CFA (outside FAPI rules)
As this spread, 94.1 introduced: if the principal purpose was to defer tax, then
notional income of 100% will be attributed x rate of interest
Key: is this a reasonable conclusion (with Casurina it is since targeted Cdns but
a world-wide mutual fund?)
Point: 94.1 was meant to deal with C. but big question on how it would affect a
Bermuda mutual fund vehicle that targets investors world-wise. TP would
argue its a bona fide inv
See budget re commentary & rules on foreign trusts (NR trusts & 94.1 will be changed by this budget)
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Domestic Transactions
s. 85
- Property to a company for shares
s. 87
- Merger of Cancos
s. 86
- Reorganizations
s. 88(1) - Liquidations / wind-up (must own 90% of subsidiary)
FA Transactions
85 = 85.1(3)
87 = 95(2)(d)
85 = 95(2)(c)
s. 85.1(3)
1)
CanCo
|
FA1
CanCo
|
FA2
|
FA1
Originally: ACB = 100, FMV = 175
Could FA2 issue $150 note & 25 shares & achieve a tax-free rollover?
85.1(3)
(a) Cost of property = FMB
(b) Cost of shares received by FA2 is deemed to be the amount that the ACB of FA1 shares (100) exceeds 150 = 0
ACB for FA2 shares
(c) Proceeds of disposition = Non-share consideration + cost of shares 150 + 0 = 150
(d) Cost to FA2 of share = TPs proceeds of disposition = 150
After:
As a rule, cant transfer property from a Canadian corporation to a foreign corporation. Can transfer property from
one foreign affiliate to another however - but only tax free to extent non-share consideration does not exceed ACB.
2)
CanCo
|
FA (U.S.)
CanCo
|
Berkshire
|
30
FA
3)
CanCo
|
USCo (5%)
CanCo
|
Berkshire (2%)
|
FA
Transfer of 5% USCo to 2% B
NA since USCo not a FA
4)
CanCo
|
BermCo (100%)
|
USCo (100%)
5)
Mr. X
Mr. Forlorn
|
|
CanCo
F Co Can
| (100%)
|
BermCo
| (50%)
| (50%)
|
USCo ---------------------------------
Would recommend that Mr. F set up the same structure as Mr. X (i.e.: transfer FCo shares of USCo to a newly
created BermCo for shares in BermCo) to avoid immediate recognition of c.g. if F Co Can decided to sell
USCo shares. {i.e.: Goal is to benefit from the excluded property rules)
Can this be done via 85.1? No 85.1(4) Exception: May not use this rollover where the goal is to transfer the
property into excluded property as a series of transaction to sell USCo, exempt from c.g.
Excluded property includes shares but cant use 85.1 to create this opportunity prior to a sale that
would otherwise be taxable.
Note: not always good to set up a BermCo since high dividend flow would be subject to a 30% WT as opposed
to a 5% under the treaty.
95(2)(c)
CanCo
|
FA1
|
FA2
FA1
|
FA3
|
FA2
87(8.1) - defn of foreign merger: FAs each resident in the same country. If within defn, 95(2)(d) simply refers you
back to 87(8).
CanCo
/ \
FA1 FA2
95(2)(d) - FA1 must be a FA. Doesnt say that FA2 & FA3 have to be FAs (could have a 9% interest).
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HK R
HK R
Cdn R
Cdn R (< 5 yrs)
HK residents came to Canada because of an affinity for Canada and the benefit of not paying tax for 5 years
Point: trusts are flexible instruments that afford the opportunity to obtain tax advantages
Question: Which of the three parties should pay tax?
HK = nobody
US = x, Cda = y
1.
Taxed on interest
Saudi Arabian comes to Canada & sets up a NR Trust with Canadian kids as beneficiaries
Per p. 137, taxed on Canadian source & FAPI under s. 94(1)(c) & (d)?
2.
Trust HK kids
- 94(1)(c) not applicable
Trust HK kids in Canada - 94(1)(c) not applicable
Trust NR kids
- 94(1)(c) not applicable
Trust Cdn kids
- 94(1)(c) not applicable (need > 60 mths)
s. 94 - 2 Conditions
(a) Canadian beneficiary, and
(b) Canadian related settlor
If conditions exist, then s. 94 applies:
(c) Discretionary trust (trustee has discretion re: distribution, etc.) is deemed to be a resident Canadian trust
per 94(1)(b)(i)(A)(III) - Settlor must be resident in Canada for 60 months (5 yrs). Thus, not until the 5 th year that
the trust will be deemed resident (at 60 months, deemed R for that whole calendar year as a trusts fiscal year is the
calendar year). Effectively gives a 5-year break for immigrants (is one reason why Canada has attracted
immigrants)
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Trusts are a flow-through vehicle: Taxed if they do not distribute income & credited to the extent that they do
distribute.
But can avoid taxes completely for 5 years by keeping it in the trust. Leave it in and distribute is after 5 years as a
tax-free distribution of capital. (However, merely waiting 1 day until the new calendar year to convert income to
capital may be targeted by Revenue Canada.)
Important rule
Assume NR Trust has 10M in income accruing but beneficiaries = 1 Canadian & 1 Hong Kong
Under 94(2), the beneficiary is jointly & severally liable for tax obligations.
Also liable for penalties, interest to the extent of his share of the distribution
Point: Canadian pays on behalf of both beneficiaries. Beneficiary can then turn around and sue the trustees.
Unique in the world. (Is a problem since a number of Canadian trusts were not complying with the law)
Legally not a sham but unfair to be able to set up an offshore trust and not pay tax
Where someone can become a beneficiary, they are today. But, per (iii), must be a Canadian R related to
settlor(?)
Where no power to add and have either 2 UK benefs or 2 Canadian benefs, should be okay
Despite the change in the law, can presumably still have a HK settlor & Canadian kids
Budget:
Any time that a Canadian R sets up a NR Trust, the trust will be deemed R
If started with 10M & accumulate 30M before it becomes R, the 30 will be taxed when it comes out
Cuts out the abuse but with ridiculous results. Will lead to non-respect of the law.
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purchase of land & building for $5M & 1M respectively to avoid recapture
Allowed by SCC: one TP avoids recapture but the other loses out
New developments since book put together: 3 new cases.
Older cases, like Stubart, is still good law but Rev. will increasingly rely on GARR (even if transaction is legally
valid, its an abuse of the Act).
Evasion v. Avoidance
Evasion = Fraud
In Switzerland, fraud does not arise solely from not reporting; need an intent to deceive.
In Canada, the more it looks legal, the more its perceived as non-fraudulent. Other countries would see
multiple corporations & contracts as fraud.
Evasion is not defined in the Act but clearly provided for at s.239(1)
239(1) - Anyone who wilfully deceives, conspires, omits, makes false entries is guilty of an offense
Redpath (141)
Clearly established to take a cut of the raw material headed to Canada for processing, thus reducing the
profitability of Canadian operations
Crown lost their case because, from a rule of law standpoint, there was no deception. There were contracts &
everything was above board.
May have won if they pursued civilly but unable to meet the criminal BOP.
Myers (141)
2 offshore corps; TP was owner the two & ran a financial publication.
Tax-driven arrangements
e.g.: buy an aeroplane for $10M. Cant deduct more than the CCA. Therefore, will lease it from a third party
for 15 years at an inflated amount, thus entitling TP to a deduction. After the 15 years, will buy it for $1, but it
will still have a value of $5M
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Stubart: No business purpose test. If a transaction follows the ITA & is technically correct, its legit. However, SCC
also laid out a 3 step test to see if a transaction is outragous - if so, could be stopped.
Issue: Where there is no business purpose to a transaction, can you do a transaction to reduce tax burden?
94.1 - If you invest in an offshore investment fund, that is not a foreign affiliate, and a main purpose is to
avoid taxes, will have to report income earned in on current basis
Announce in Feb that it will be modified to remove a purpose test (caught automatically)
SCC: If the transaction is legally effective, / if the transaction is legally ineffective or a sham, dont need a BPT
as it will fall on its own.
If drafted with the intent to restrict to target specific a group / transaction, will also find a BPT.
Example of Stubart
Appeal: In substance, you borrowed in $US, can only claim 9%, not 17% as the difference is merely a
prepayment of capital.
Using provisions of the ITA to reduce taxes owing (RRSPs, losses to offset other income)
4th Problem - p. 157
Q: Client asked to pay kickbacks to foreign officials. Is it a deductible expense?
Questions:
1. Do you need a conviction in the other jurisdiction to be caught under it? Revenue says so but Mason
disagrees; how could a Rev. official judge what will be held illegal in another country?
2. Public policy concerns: illegal activity
Specific anti-avoidance provisions are numerous
15 SH
69 FMV
Trans-national Anti-Avoidance - pp. 147-48
Profit diversion
Profit Extraction
Emigration of corporation
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GARR - s. 245
Introduced in the late 1980s
245(1) - Defns
245(2) - Charging provision
Where a transaction is an avoidance transaction, the tax consequences will be determined according to what is
reasonable in the circumstances.
245(4) - Big carve-out
NA to a transaction where it may be regarded that there will not be a misuse or abuse of the Act, but for this
section.
Only 3 cases decided - all won by the fiscus
1) McNicholl, Tax Ct
Bonner, J. - Jan 97
Partners in a law firm; had a mgmt co. that owned a building. P dissolved, building sold for a gain.
Mr. X buys mgmt co. from partners, who are paid tax free, given the lifetime CP exemption
Is this GARR-able?
Held:
At issue is only cash, no real business. Sole motivation is tax purposes, constituting a misuse & abuse of the
Act.
Bowman, J. - Apr. 97
3rd party (also in the US) found to buy the shares of the company, who can claim treaty protection under the
Canada-US Convention (no tax)
Held:
Tardif, ~ Feb. 98
Manufacturing of PUC in a corporation by borrowing money to create a NewCo with higher PUC
Lost in court
State of the law today
Tax planning still works - i.e.: reduce taxes in the course of carrying on a business, etc.
Lower courts have been very favourable towards the fisc; remains to be seen how the SCC will view GARR.
Time will tell how GARR applies to various transactions under the Act.
Exam
37