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Cross Border Update
Presented By:Jules Lewy, Duane Milot and Christopher Steeves
March 26, 2008
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FMC Tax Bench Strength
Calgary: (403) 268-7000 Edmonton: (780) 423-7100 Montreal: (514) 878-8800 Toronto/Ottawa: (416) 863-4511 Vancouver: (604) 687-4460
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Overview – Christopher Steeves
Case Law Foreign Investment Entities and Non-Resident
Trusts Section 116 Clearance Certificates Voluntary Disclosure Transfer Pricing Ontario Corporate Tax Harmonization Interest Withholding Tax US Treaty
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Case Law Update – Duane Milot
CanWest Mediaworks Inc. v. The Queen, 2008 DTC 6070 (FCA)
• Canadian taxpayer was reassessed FAPI in respect of a subsidiary resident in the Barbados over 7 years after the end of taxation year
• Taxpayer had provided a waiver under the ITA• Canada-Barbados Tax Treaty provides that a State
shall not increase the tax base of a resident after 5 years from the end of the taxation year
• However, the Treaty also provides that nothing in the Treaty “shall be construed so as to prevent Canada from imposing FAPI”
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Case Law Update (cont.)
CanWest Mediaworks Inc. v. The Queen• TCC: 5 year limitation period applied - Minister was out
of time to reassess the Taxpayer• FCA
reversed TCC decision and held that 5 year limitation period did not apply
language of the FAPI provision was “unqualified” and was “intended to prevail” over every other contrary provision in the Treaty
5 year limitation period can still apply to income that is not FAPI
• Taxpayer appealed to SCC on March 7, 2008
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Prevost Car Inc. v. The Queen (TCC)• FMC argued this case in September, 2007• Dealt with meaning of “beneficial owner” of
dividends under the Canada-Netherlands Tax Treaty
• Netherlands corporation set up with UK and Swedish corporate shareholders
• CRA position Netherlands company was mere conduit for UK and
Swedish shareholders, and not beneficial owner tax withheld should be 10/15% instead of 5%
Case Law Update (cont.)
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Case Law Update (cont.)
Prevost Car Inc. v. The Queen • Taxpayer position was that Netherlands
corporation was beneficial owner of dividends: Business purpose – neutral European country,
facilitate other joint ventures Parties had valid shareholders agreement and
resolutions Dividends were properly declared by directors No support in law for CRA’s position
this is not treaty shopping, agent or nominee case
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Garcia v. The Queen, 2007 DTC 1593 (TCC) – IP• Taxpayer was French citizen, moved to US for
employment until 2002, then moved to Canada• Taxpayer received a bonus in 2003 in respect of his
employment in 2002 • Taxpayer filed tax return in Canada in 2003 as non-
resident and deducted bonus as foreign earned income• Taxpayer did not pay tax in US on bonus due to
exemption under US domestic law• CRA assessed Taxpayer for 2003 and included bonus
in income• Parties agreed that Taxpayer was ordinarily resident in
Canada
Case Law Update (cont.)
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Garcia v. The Queen• Taxpayer argued that
He was resident of the US under tie-breaking rules of Article IV of Canada-US Tax Treaty
Even if resident of Canada, the bonus was derived from employment held while he was a resident of the US, and under Article XV was taxable only in US
• TCC Taxpayer was resident in Canada because he had a
“permanent home” available to him in Canada Employment income is taxable when received. As the
bonus was received when the Taxpayer was a Canadian resident, the bonus is taxable in Canada even though it was derived from employment that he exercised in the US
Case Law Update (cont.)
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Case Law Update (cont.)
Knights of Columbus v. The Queen• FMC argued this case in January, 2008• Dealt with meaning of “permanent establishment” under
paragraph 1 and 5 of Article V of Canada-US Tax Treaty• US fraternal benefit society was reassessed on basis that
it had a PE in Canada• CRA position:
its sales agents, while carrying on their own business in Canada, were contemporaneously carrying on the Taxpayer’s business in Canada through their home offices
temporary insurance agreements resulted in a PE
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Case Law Update (cont.)
Knights of Columbus v. The Queen• Taxpayer position was that it did not have a
PE in Canada as 1) there was no fixed place of business in Canada
through which its business was carried on home offices not at disposal or control of Taxpayer
2) their agents did not have the authority to conclude contracts in Canada on behalf of Taxpayer
All decisions were made in the US and the insurance contracts were concluded in the US
Temporary insurance agreements were not part of business proper, and were preparatory in nature
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Case Law Update (cont.)
eBay Canada Ltd. v. The Queen, 2007 DTC 5573 (FC)
• Applicants were the direct and indirect Canadian subsidiaries of eBay Inc.
• Applicants applied for a review of an Order issued ex parte under section 231.2 of ITA
• Order required the Applicants to provide account information (name, address, merchandise sales information) of “PowerSellers” to CRA
• Applicants did not want to divulge this information• Information was located on computer servers that were
not located in Canada, but the Applicants could access the information
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Case Law Update (cont.)
eBay Canada Ltd. v. The Queen• Issue: Whether section 231.2 of the ITA permits an
Order that will require a Canadian resident to provide information which it has access in Canada but which is stored in data facilities owned by another party outside of Canada
• Federal Court: Yes. This information must be disclosed to the CRA. The information is readily and instantaneously available to the Applicants who use this information to deal with PowerSellers in the ordinary course of their business
• An appeal was filed in the Federal Court of Appeal on March 7, 2008
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NRTs and FIEs – Jules Lewy
New Non-Resident Trust ("NRTs") and Foreign Investment Entities ("FIEs") Legislation.
Principally Deals with sections 94 and 94.1 of ITA.
First introduced in February 1999 Budget. Numerous drafts of legislation have been
presented. Effective date in most recent proposed legislation
(Bill C-10) is generally January 1, 2007.
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Effect of Proposed Legislation
Many non-resident trusts with Canadian connections are deemed to be resident in Canada and subject to Canadian tax.
The FIE rules prevent Canadians from deferring or reducing taxes by investing in a foreign entity and requires that a Canadian owner of a FIE include an amount in income on the basis of:
• prescribed interest rate;• "mark to market" regime; or• a modified accrual regime.
Present legislation in Bill C-10, Not yet enacted – Senate Finance Committee is studying.
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NRT Proposals
Deems a non-resident trust to be resident in Canada if there is:• Resident Contributor; or• Resident Beneficiary.
Resident Contributor: person contributed to trust who is resident in Canada at the end of the relevant taxation year.
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NRT Proposals
Resident Beneficiary:• person "beneficially interest" in trust resident in Canada
and• "connected contributor" - a contributor who made a
contribution to trust at a time which is not a non-resident time.
• "non-resident time" - contributor has not resided in Canada during the period that begins 60 months before a contribution (18 months if NRT created as a consequence of death) and ends 60 months after the contribution.
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Definition of Contribution
Critical concept. Very extensive list of situations.
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Canadian pension plan invests in non-resident trust which is not an "exempt foreign trust".
Exempt foreign trust requires in (h) more than 150 investors holding units, or if less than 150 investors, does not hold "restricted property".
May have strange result deeming a trust to be resident in Canada.
Examples of Problems with Proposed Legislation
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Examples of Problems with Proposed Legislation
Even if "avoid" NRT rules a non-resident trust may be "caught by FIE rules".
Under FIE rules generally an exemption for non-resident trusts, not caught by NRT rules, if trust is "fully discretionary".
But virtually impossible to have fully discretionary trust because of trust provisions dealing with what happens at end of trust period if discretion not exercised.
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What can work for NRTs?
1. Properly structured "immigration trust" – all contributions by persons who at the end of the year have not resided in Canada for 60 months.
2. Properly structured "in bound trust" - all contributions meet the "non-resident time test" even if Canadian resident beneficiaries.
3. Properly structured "out bound trust" - if a Canadian contributor who is not alive and all beneficiaries are non-resident.
4. NRTs taxable in Canada e.g. "wealth preservation trusts".
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Section 116 Clearance Certificates – Christopher Steeves
Required when there is a disposition of taxable Canadian property (TCP) by a non-resident of Canada (other than excluded property)
TCP includes (among other things):• real property situated in Canada• shares of corporation resident in Canada
Excluded property includes (among other things):• Shares listed on a designated stock exchange
T2062 notice form filed by non-resident vendor with details of the transaction
Purchaser required to withhold 25% of the purchase price on account of the vendor’s Canadian tax liability in respect of the disposition (assuming the TCP is not depreciable property) unless it receives a clearance certificate
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Section 116 Clearance Certificates
Withholding required even where no tax is payable by the non-resident (no gain, treaty exemption, section 85)
Process to obtain clearance certificate may take several months
CRA will issue comfort letters so that purchaser is not required to remit the withheld amount within 30 days after the end of the month in which the disposition occurs
Comfort letter saves the vendor from having to wait until after the end of the year of sale to file a tax return and claim a refund of the withheld amount – instead the purchaser remits the withholdings to the vendor when the clearance certificate is finally obtained
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Section 116 Clearance Certificates
This procedure has negatively impacted on foreign investment in Canada
• Ties up the sale proceeds for seller for months• High cost of Canadian tax compliance• Recent survey of U.S. venture capitalists (VCs)
40% cite Canada’s unfavorable tax environment as a key reason for not investing in Canadian companies
The report specifically named section 116 certificate requirements as the primary tax impediment for VCs
Budget 2008 contains new provision intended to reduce this compliance burden
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Section 116 Clearance Certificates – Excluded Property
Applies to dispositions that occur after 2008
Expands meaning of “excluded property” to include property that is “treaty-exempt property”• Must be “treaty-protected property” as defined
in ss 248(1) and• Where the purchaser and vendor are related
the purchaser must provide notice under new ss 116(5.02)
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Section 116 Clearance Certificates – Safe Harbour
“Treaty-protected property” means property any income or gain from the disposition of which would be exempt from tax under Part I of ITA because of a tax treaty with another country
Safe harbour? The purchaser is not required to withhold 25% of the
purchase price if (a) the purchaser concludes, after reasonable inquiry, that the vendor is resident in a treaty jurisdiction; (b) the property would be “treaty-protected property” of the non-resident person if they were resident in the treaty jurisdiction; and (c) the purchaser provides notice under ss. 116(5.02)
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Second requirement of safe harbour has no reasonable inquiry defence If purchaser incorrectly concludes that the property is “treaty-protected
property” it can be liable for failing to withhold 25% of the purchase price• Property would not be treaty-protected property where, for example,
a US resident vendor used the property in a business carried on through a permanent establishment in Canada
the vendor was formerly a Canadian resident the limitation of benefits provision of a treaty is applicable
• Where there are more than one vendor, this determination can be complicated
• Determination cannot usually be independently verified by a purchaser - failing to withhold against purchase price may be considered too risky?
Expect that few arm’s length purchaser will take this risk Hopefully, the reduced applications from non-arm’s length
purchasers will speed remaining applications in the system
Section 116 Clearance Certificates – Safe Harbour
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Section 116 Clearance Certificates - Purchasers
New filing requirements created for purchasers under ss 116(5.2) – applicable where related parties want property to fall under definition of “excluded property” or where safe harbour provisions are to apply
Required to provide notice of acquisition of TCP on or before the date that is 30 days after the acquisition date
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Filing Canadian Tax Returns
Budget 2008 also amended the requirement for a non-resident vendor of TCP to file a Canadian tax return for the year of disposition
Must be an “excluded disposition”• TCP must be “excluded property” including the new
amended definition OR• A section 116 clearance certificate was obtained
To avoid the filing requirement, the non-resident cannot owe any Canadian taxes under the ITA (unless the CRA holds adequate security for such taxes under sections 116 or 220)
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Voluntary Disclosures – Jules Lewy
Frequently utilized in cross-border situations:e.g. • unreported off shore bank accounts;
e.g. • non-resident carrying on business in Canada and omits to file a Canadian tax return.
Requirements set out in IC00-IR2 dated Oct. 22, 2007.
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Requirements for Voluntary Disclosure
Voluntary Complete Penalty Involved Information at least 1 year past due
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Requirements
Most recent Information Circular in October 2007
New form to be used 10 year limitation period "No Name" Disclosures Centralized for Ontario and Nunavut in
St. Catherines district office.
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Jurisprudence on Voluntary Disclosure Refusals.
Les Peintres Filmar Inc. 2007 DTC 5420 (FCA)
Paloneck 2007 DTC 5566 (FCA) Wong 2007 FC 628 (FCTD)
Jurisprudence on Voluntary Disclosures
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Transfer Pricing – Christopher Steeves
#1 issue for tax directors with multinational organizations
CRA continues to apply significant resources to the transfer pricing audits
• CRA now has 28 economists working in the International Tax Division and are hiring 6 more
CRA is developing a long list of policies ranging from use of multi-year data to notional charges for branches – should slowly trickle to the public over the next few years
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Mutual Agreement Procedures
Article XXVI of the Treaty contains the mutual agreement procedures (MAP) which authorize the competent authorities of Canada (CRA) and the United States (IRS) to consult together to attempt to alleviate cases of double taxation
The MAP are particularly important in resolving disputes with CRA relating to transfer pricing
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Mutual Agreement Procedures
The MAP are essential to ensure that any adjustment to the taxable income of a taxpayer in Canada is offset by a corresponding adjustment to the related taxpayer in the other jurisdiction
The MAP provide taxpayers with the ability to request a meeting of the relevant competent authorities to resolve issues of double taxation arising from adjustments
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Competent Authority
Request for competent authority assistance must be made in writing (important that request made within time frame specified in relevant tax treaty – U.S. - 6 years from the end of the taxation year)
At this time there is no charge for competent authority assistance
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Competent Authority
After request made, competent authorities will attempt to resolve the issue to mutual satisfaction of parties involved
Under the Treaty, Canadian taxpayer is represented by Canadian Competent Authority, and does not directly participate in discussions or resolution
Process takes about 2 years to complete While there is usually a resolution – there are no
guarantees
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Mutual Agreement Procedure Program Report
CRA released its report for the period between April 1, 2006 and March 31, 2007 in mid-summer, 2007
Contains details about the MAP which show some interesting trends worth noting
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Mutual Agreement Procedure Program Report – Completed Cases
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Mutual Agreement Procedure Program Report – Breakdown by Country of Completed Cases
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Mutual Agreement Procedure Program Report – Breakdown by Industry of Completed Cases
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Mutual Agreement Procedure Program Report - Results
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Mutual Agreement Procedure Program Report – Reasons for No Relief or Partial Relief
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Mutual Agreement Procedure Program Report
Interesting Trends revealed in this Report• CRA is applying significant resources to auditing and
assessing transfer pricing adjustments• 86% of all completed cases were initiated by CRA• 65% of all completed cases involved the U.S.
competent authority• A broad range of different industries are affected• 8% of all cases completed left the affected taxpayers
with some element of double tax
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Ontario Harmonization – Jules Lewy
October 2006 Memorandum of Agreement Effective for Taxation Years after 2008 5% Add-Back for payments to non-residents for:
• Certain management and administration fees;• Certain rents, royalties and similar payments;• Certain payments for Canadian use of films and TV videos.
Subsection 11(5) of the Ontario Corporations Tax Act Ontario Tax Interpretation Bulletin 3004 dated January
2002. Add-Back will be eliminated with Harmonization. Savings estimated at $70 million per year.
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Non Resident Withholding Tax – Jules Lewy
2007 Budget announced elimination of non-resident withholding tax paid to arm's length parties residing in any jurisdiction.
Bill C-28 received Royal Assent December 14, 2007.
Effective January 1, 2008• Eliminates need for section 212(1)(b)(vii) – 25%/5 year
loan.• Exception "Participating Debt Interest"• Key: Arm's Length – section 251• Thin Capitalization Rules in subsection 18(4) may apply
to deny interest deductibility
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Signed on September 21, 2007. Amends the Canada – US Income Tax
Convention. Comes into effect when ratified by Canada
and the US and Instruments of Ratification exchanged.
Canada ratified in December 2007. Technical Explanation.
Fifth Protocol to the Canada-US Income Tax Convention - Jules Lewy
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Fifth Protocol – Interest Withholding Tax
Presently 10% (Article XI) Protocol reduces to 0% for parties who
are not related (Defined in Article IX), two months after Protocol ratified.
However the Canadian Income Tax Act provision is in effect now.
May effect certain interest payments from US to Canada
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Fifth Protocol – Interest Withholding Tax
For related parties rate is reduced from 10% to 7% in year 1 from January 1.
For related parties rate is reduced to 4% in year 2 from January 1.
For related parties rate is reduced to 0% in year 3 from January 1.
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Fifth Protocol – Interest Withholding Tax
New rates under Protocol do not apply if rate of interest is participating interest – then 15% withholding (Article XI (6)(b) – broad definition).
New rates under Protocol do not apply if the amount is not reasonable (Article XI(5)).
Thin Capitalization Rules and deductibility of interest restriction cannot be forgotten.
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Fifth Protocol – Guarantee Fees
Section 214(15)(a) of ITA imposes withholding tax
Article 22 of Treaty amended to eliminate withholding tax on guarantee fees.
Effective two months after Protocol ratified?
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US Tax Treaty Update – PE – Duane Milot
Permanent Establishment definition • Article V of the Canada-US Tax Treaty will be
amended to provide that where an enterprise of a State provides services in the other State, that enterprise will be deemed to provide those services through a PE in the other State in two circumstances
• Effective third taxable year after Protocol enters into force
• Government’s response to the Dudney v. The Queen decision, 2000 DTC 6169 (FCA) US resident provided services in Canada for 300 days in
1994 CRA alleged that US resident had “fixed base” in
Canada, but FCA disagreed
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US Tax Treaty Update – PE (cont.)
• Permanent Establishment will exist if: those services are performed in that other State by
an individual who is present in that other State for a period or periods aggregating 183 days or more in any twelve-month period, and,
during that period or periods, more than 50 percent of the gross active business revenues of the enterprise consists of income derived from the services performed in that other State by that individual
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US Tax Treaty Update – PE (cont.)
• Permanent Establishment will exist if: the services are provided in that other State for an
aggregate of 183 days or more in any twelve-month period with respect to the same or connected project for customers who are either residents of that other State or who maintain a PE in that other State and the services are provided in respect of that PE
projects will be considered to be connected if they constitute a coherent whole, commercially and geographically
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Fifth Protocol – Limitation On Benefits – Jules Lewy
MIL decision 2007 DTC 5437 (FCA). GAAR and Treaty Shopping. New LOB provision (Article XXIX). Applies to both Canadian and U.S. taxes.
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Fifth Protocol – Limitation On Benefits
Must "qualify" to benefit from Treaty Competent Authority can be used if not
otherwise entitled, if meet tests (Article XXIX (6))
New compliance burden. Abuse of Provisions of Treaty (Article
XXIX (7)).
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Mandatory Arbitration – Christopher Steeves
The Fifth Protocol proposes to substantially amend paragraph 6 of Article XXVI and would introduce a new mandatory arbitration procedure
Intended to ensure that the mutual agreement procedures proceed according to a schedule and that all cases will be resolved within a time period not exceeding approximately 35 months
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Mandatory Arbitration
Requires arbitration of qualifying cases that are unresolved two years
“Baseball” or “last best offer” arbitration – one party wins – one party loses
Primary objective - more efficient resolution of cases by competent authorities prior to the date that referral for arbitration is required
Will apply to cases already in the system when Protocol enters into force and cases that follow
Controversial?• also in the U.S. Treaties with Germany and Belgium• these treaties were ratified by the U.S. Senate on December
14th, 2007.
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Hybrid Entities – Christopher Steeves
U.S. Limited Liability Corporations (LLCs)
CRA’s current position is that LLCs are not entitled to benefits under the Treaty because they are not residents of the U.S. for purposes of the Treaty
Definition of “resident” under the current Treaty states that the entity must be liable to tax
An LLC is generally not liable to tax – its members are
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Hybrid Entities
U.S. Limited Liability Corporations (LLCs)When the Protocol enters into force, in order to determine Treaty benefits applicable to income, profit or gain, LLCs will be treated as look through entities and benefits will be afforded to members that are resident in the U.S. (Article IV(6))
No indication yet that the current entitlement to Treaty benefits of U.S. S Corporations will change when the Protocol is enacted
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Hybrid Entities
U.S. LLCs and Limited Partnerships Under the current Treaty, where a U.S. corporate
shareholder holds more than 10% of the voting shares of a Canadian corporation, dividends paid by the Canadian corporation will be subject to 5% Canadian withholding tax (instead of 15%)
Look through provisions in the Protocol will allow corporate members of a flow-through entity to benefit from 5% reduced rate on dividends paid by a Canadian corporation – Article X(2)(a)
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Hybrid Entities
Practical Issues How will residence of LLC/LP members/partners
be substantiated? How are Treaty provisions applied if not all
members are U.S. resident (i.e. permanent establishment exemption)?
s.116 Clearance Certificate issues remain re disposition of taxable Canadian property by an LLC– each member of LLC requires clearance?
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Hybrid Entities
Protocol will deem certain entities to be non-resident under the Treaty causing loss of Treaty benefits – Article IV(7)
Main targets: structures used for double dipping (tower structures) but surprise is that Protocol will also impact other widely used cross-border structures
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Hybrid Entities
Unlimited Liability Corporations (ULCs) Nova Scotia, Alberta and BC have
corporate legislation permitting ULCs For Canadian tax purposes – ordinary
taxable corporation For U.S. tax purposes – may qualify as
disregarded entity (under U.S. ‘check the box’ rules)
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Hybrid Entities
Unlimited Liability Corporations (ULCs) Impact of Article IV(7)(b) - payments made by ULC (i.e.
dividends, interest, royalties) will not be considered paid to a resident of the U.S. and therefore, subject to Canadian withholding tax at 25%
LLC
Canada: ULC treated as CorporationU.S.: ULC Disregarded
DividendsU.S.
Canada
OPCO
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Hybrid Entities
LLCs often used by Canadian taxpayers doing business in US• Treated as an ordinary corporation for purposes of foreign affiliate
rules Impact of Article IV(7)(a)-payments made by LLC (i.e. dividends,
interest, royalties) will not be considered paid to a resident of Canada and therefore, subject to US withholding tax at 30%
US active business income subject to ordinary tax rate (34%) and branch profits tax (30%)
CanCo
Canada: LLC treated as CorporationU.S.: LLC Disregarded
DividendsCanada
US
US LLC
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Planning Ahead
Cross border structures will need to be reviewed and reconsidered• Hybrids used for U.S. corporate tax planning• Double dipping – “Tower structures”
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Planning Ahead
Possible alternatives to manage change of ULC treatment• Transfer ULC shares to another disregarded
entity (i.e. Luxembourg)• Dissolution of ULC – carry on business in
Canada as a branch • Elect to treat ULC as corporation
