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INBOUND FINANCING AND INVESTMENTS
2010 MINING TAXATION UPDATE
ACUMEN INFORMATION
MAY 10, 2012
Steve SuarezBorden Ladner Gervais (Toronto)
2
OVERVIEW OF PRESENTATION
1. Financing & Inbound Investment• Debt Financing• Equity Financing• Alternative Investments• Non-Resident Acquisitions of Canadian Mining Companies
2. Exit Strategies• Taxable Canadian property• Tax treaty protection• s.116 issues
3. Cross-Border Canada – U.S. Issues• Limitation on benefits under the Canada-U.S. Treaty• Using hybrid entities in inbound transactions
3
Financing & Inbound Investment
Non-residents making Canadian mining investments (new projects in Canada, acquiring interests in existing projects or acquiring interests in existing Canadian entities) must consider:
• Canadian income tax• Canadian withholding tax• home-county taxes• limited legal liability• day-to-day functionality
In most cases other than straightforward lending or royalties, this will involve using a Canadian corporation (directly or indirectly) as the investment vehicle
4
Financing & Inbound Investment
Debt Financing: non-residents have a number of important considerations to balance
• where to locate interest expense
• thin capitalization limitations on Canadian interest deductibility
• possibilities for double-dip financing
• Canadian interest withholding tax
• Other considerations
5
Financing & Inbound Investment: Debt
On simple loans to arm’s length borrowers, a non-resident will typically be worried only about home country taxation of interest income• no Canadian withholding tax on interest paid to a non-resident creditor dealing at arm’s length with Canadian borrower, unless interest is “participating” (e.g., variable based on profit, cash flow, etc.)
Otherwise, if non-resident is debt-financing a Canadian investment, need to consider whether• interest expense deductions are most useful in Canada or the non-resident’s home country (effective tax rate, where sufficient taxable income exists, etc.); • withholding tax costs of lending to Canada; and• is there any scope for multiple deductions?
6
Financing & Inbound Investment: Debt
Thin capitalization restrictions (s.18(4)ITA)
Canadian corporations are restricted on the amount of interest expense they can deduct on debt owing to “specified non-residents”: non-residents who own, or deal non-arm’s length with someone who owns, 25%+ of Canco’s equity (by votes or value)
No interest deduction on debt owing by Canco to specified non-residents, to the extent it exceeds 2x Canco’s “equity”, being the sum of• Canco’s start-of year unconsolidated retained earnings;• Canco’s contributed surplus received from specified non-resident shareholders; and• paid-up capital of Canco shares owned by specified non-resident shareholders
7
Financing & Inbound Investment: Debt
Thin capitalization restrictions are being tightened under the March 2012 federal budget
• debt/equity limit being reduced to 1.5:1 (effective 2013)• rules now capture debt of partnerships that have Canadian corporations as partners• disallowed interest expense with be treated as a dividend (not
interest) for withholding tax purposes
See “Canadian 2012 Federal Budget: Tightening the Screws,” included with materials
8
Financing & Inbound Investment: Debt
Foreign Parent
$50M equityForeign
Finance Co
Canco
$100Mloan
Starting in 2013, Canco can only deduct interest on $75M of the debtowing to Foreign Finance Co• no deduction for interest on the remaining $25M, which is treated
as a dividend and subject to dividend withholding tax
9
Financing & Inbound Investment: Debt
Double-Dip Structures
Where U.S. parent is lending to Canadian subsidiary, consider whether a “double dip” hybrid structure can be used to create an instrument that is debt for Canadian purposes (deductible interest expense for Canco) but equity for U.S. purposes (no interest income for U.S. parent)
10
Financing & Inbound Investment: Debt
Summary1. US Co uses proceeds of 3rd party debt to make a loan to Canco
2. Simultaneously, LLC enters into a forward subscription agreement with Canco to purchase Canco shares for cash equal to the principal amount of the loan on the maturity date
3. Simultaneously, US Co enters into a support agreement with LLC to purchase shares for cash in order that LLC can fund its obligation under the forward subscription agreement
4. Simultaneously US Co provides Canco with a guarantee of LLC’s performance under the FSA
1. Loan
US Co
CancoLLC
Third-party debt
2. Forward Subscription Agreement
4. Guarantee
3. Support Agreement
11
Summary1. Loan from US Co to Canco
2. Forward subscription agreement between LLC and Canco
3. Support agreement between US Co and LLC
4. Guarantee from US Co to Canco
Financing & Inbound Investment: Debt
US Co
Canco
LLC4. Guarantee 1. Loan
3. Support Agreement
2. Forward Subscription Agreement
12
Financing & Inbound Investment: Debt
Interest Withholding Tax
Under Part XIII, Canada no longer levies withholding tax on interest (other than participating interest) paid to a creditor dealing at arm’s length with the debtor
“participating debt interest” means interest (other than interest described in any of paragraphs (b) to (d) of the definition “fully exempt interest”) that is paid or payable on an obligation, other than a prescribed obligation, all or any portion of which interest is contingent or dependent on the use of or production from property in Canada or is computed by reference to revenue, profit, cash flow, commodity price or any other similar criterion or by reference to dividends paid or payable to shareholders of any class of shares of the capital stock of a corporation.
13
Financing & Inbound Investment: Debt
Interest Withholding Tax: other relevant provisions
s.214(6): deemed payment of accrued interest on transfer of bond, etc. by a non-resident to a Canadian resident, if bond issued by Canadian resident
s.214(7): deemed payment of interest on transfer of bond, etc. by a non-resident to a Canadian resident, if issued by Canadian resident and transfer price exceeds issue price of the bond
s.214(8): “excluded obligations”, carved out of s.214(7) and partially carved out of s. 214(6) (former 5/25 debt or shallow discount debt issued for not less than 97% of principal amount)
14
Financing & Inbound Investment: Debt
Interest Withholding Tax: convertible debentures
There is considerable uncertainty as to the tax treatment of holders of convertible debentures who are non-residents• not clear whether the value of shares received on conversion
over principal amount is “participating interest” (if so Canadian withholding tax applies on sale or conversion of debenture)• not clear whether “regular” interest is tainted by the conversion premium
CRA administrative position has been “under development” for almost 4 years, and remains in progress
15
Financing & Inbound Investment: Debt
Interest Withholding Tax: Tax treaty structuring
While most of Canada’s tax treaties reduce the 25% rate of Part XIII interest withholding tax to 10%, the rate under the Canada-U.S. Treaty for U.S. residents entitled to Treaty benefits is 0%, even if dealing non-arm’s length with the debtor
➙ This creates an incentive for non-residents outside the U.S. to consider financing into Canada through a U.S. group member, in order to get 0% interest withholding
Issues to watch for• limitation on benefits under the Canada-U.S. Treaty• anti-hybrid rules in Canada-U.S. Treaty• anti-avoidance mechanisms (discussed below)
16
Financing & Inbound Investment: Debt
Interest Withholding Tax: Financing Through the U.S.
ForeignParent
Canco
Debt(10% w/h tax)
ForeignParent
Canco
U.S. Financeco
Debt(0% w/h tax rate)
17
Financing & Inbound Investment: Debt
s.78: Accrued and Unpaid Interest:
Deductible amounts owing to a non-arm’s length person and which remain unpaid at the end of the second taxation year following the year it was incurred, are added back to income in the third following year, unless the parties jointly elect to deem the amount to have been paid
Figure 1. Accrued Non-Arm’s-Length Interest and Section 78(1)
Interest accrues for 2009
12/31/08 12/31/09 12/31/10 12/31/13 12/31/12
Payment deadline for 2009 interest
Deemed-payment election deadline
12/31/11
18
Financing & Inbound Investment: Debt
Foreign Exchange Issues
When lending into Canada, consider the F/X implications of the loan
• Canadian debtor borrowing non-Cdn. $ will realize income/gain/loss on maturity, with any loss probably denied recognition if incurred on debt from a non-arm’s length lender
• Canadian debtor should not assume any gain will be a capital gain: need to consider capital/income treatment
• Canco may want to consider making the s.261 foreign currency election in appropriate circumstances
For more on the tax treatment of F/X gains and losses, see “Canadian Taxation of Foreign Exchange Gains and Losses” at www.miningtaxcanada/about/
19
Financing & Inbound Investment: Equity
Equity Financing: principal Canadian tax considerations for non-residents making an equity investment in Canada:
• tax recognition of cost of investment
• maximizing cross-border paid-up capital (PUC)
• minimizing Canadian dividend withholding tax
• minimizing Canadian taxation of gains on exit
• managing s.116 obligations on sale
20
Financing & Inbound Investment: Equity
Paid-up Capital
• Tax equivalent of corporate law share capital
• Basic concept is that shareholders should be able to extract PUC without being treated as receiving a dividend (but reduces shareholder’s cost in the share)
• Each share of the same class or series has the same PUC (PUC of class divided by # of shares)
21
Financing & Inbound Investment: Equity
Y
$200
FMV = $200Cost = $100PUC = $150
CanCo
Cost/FMV = $200PUC = $150
X
$200
FMV = $200Cost/PUC = $100
CanCo
Before
X Y
After
Paid-up Capital: pooled within each class
22
Financing & Inbound Investment: Equity
Paid-up Capital: non-residents
Especially important for non-resident purchasers
• PUC can be extracted out of Canada without dividend withholding tax
• PUC increases how much debt Canco can incur from related non-residents on an interest-deductible basis
• 2012 federal budget targets PUC increases where foreign-controlled Canco makes an “investment” in a foreign affiliate that does not satisfy a business purpose test (see “Canadian 2012 Federal Budget: Tightening the Screws”)
23
Financing & Inbound Investment: Equity
Paid-up Capital: non-resident acquisition
$10M
FMV = $10MPUC = $2M
Canco
Non-ResidentBuyer
Vendor
24
Financing & Inbound Investment: Equity
Canco
Incorrect
Non-ResidentBuyer
FMV/Cost = $10MPUC = $2M
Vendor
$10M
New Canco
Correct
Non-ResidentBuyer
FMV/Cost/PUC = $10M
Vendor
$10M
FMV/Cost = $10MPUC = $2M
Canco
25
Financing & Inbound Investment: Equity
Equity Distributions
A Canadian corporation can choose to make a distribution to shareholders either as (1) a dividend, or (2) a return of capital (to the extent of the stated capital of its shares)
• unlike the U.S., there is no rule treating all distributions as dividends for tax purposes to the extent the corporation has earnings & profits (E & P)
A dividend triggers dividend withholding tax but does not reduce the holder’s basis in the share
A return of capital reduces basis in the share and is not treated as a dividend to the extent of PUC (except where s.84(4.1) applies)
26
Financing & Inbound Investment: Equity
Equity Distributions
In a mining investment, the prospect of dividends is often remote unless the Canadian corporation is a producer of significant size (mining is very capital-intensive)
• dividend-paying mining corporations tend to be large public companies, which are severely limited in their ability to make capital reductions for tax purposes due to s.84(4.1)
As a result, choice of jurisdiction to hold Canadian mining shares is usually driven by (1) recipient-country taxation, and (2) managing Canadian taxation of gains on dispositions, (see Exit Strategies)
27
Dividendfrom Canco
PUC Reduction from Canco
Loan from Canco
Withholding Tax
25%; potentially reduced as low as 5% by tax treaty (note Canada-U.S. problem with ULCs)
None if sufficient PUC; reduces holder’s basis in shares of payer
None if repaid within permitted timeframe and not part of a series of loans and repayments; otherwise treated as a dividend
Comments Consider whether relevant Canadian corporate law places any constraints on Canco’s ability to declare and pay dividend (e.g., solvency test)
No U.S. style E&P rule; can choose to reduce PUC even if profits exist (subject to s.84(4.1) for public corporations)Consider effect on thin capitalization rules to Canco
Various rules require market interest rate to be charged by Canadian lender
Financing & Inbound Investment: Periodic Repatriations
28
Financing & Inbound Investment: Royalties
It is relatively unusual for foreigners to invest in a Canadian mining project in the form of a royalty, as these tend to be tax-inefficient
• effectively no cost recognition for Canadian purposes, as CDE pool rarely of use to a non-resident
• royalties subject to 25% withholding tax under Part XIII
• Canada’s tax treaties tend to offer little or no relief from Canadian taxation of Canadian-source mining royalties
29
Financing & Inbound Investment: Metal Streams
Metal stream transactions are a particular form of mining transaction that typically sees a producer sell secondary output (e.g., silver from a gold mine) to an arm’s length purchaser, usually on the basis of an upfront payment plus a relatively low price per unit delivered (considerably less than spot)
• structured so as not to be a royalty
• up-front payment often set up as a deposit
While possible to effect directly into Canada, (especially where the mine is located in Canada) metal stream transactions are typically set up with a foreign subsidiary of the Canadian mining company
30
Financing & Inbound Investment: Metal Streams
Income Tax Results:• Vendor: payments from
Vendor Subco included in income when received
• Vendor Subco: upfront payment included into income when received; s. 12(1)(m) reserve claimed for goods to be delivered in future. Sales income from Purchaser included into income as received.
Vendor
VendorSubco
MineSpotContract
Purchaser
ForwardContract
Vendor sells output to vendor Subco at spotVendor Subco sells output to Purchaser at lesser of spot and Kn price, with an upfront payment
31
Financing & Inbound Investment: Acquisitions
Acquisitions of Canadian mining companies: see B. Sinclair’s presentation
• form of transaction• form and amount of consideration• process• structuring considerations
purchaser (s.116 issues, s.88(1)(d) bump, exit strategy)
vendor (tax minimization, deferral, s.116 issues)• pre-and-post transaction planning
32
Financing & Inbound Investment: Acquisitions
Points of particular relevance to non-resident purchasers
• maximizing cross-border PUC (to maximize Canadian interest deductibility under thin capitalization rules and the ability to effect distributions as PUC returns)
• s.88(1)(d) bump• limited to using cash consideration• especially useful to extract Target’s foreign subsidiaries out of Canada
• limited ability to offer tax deferral to Target shareholders who are taxable in Canada on gains (unless using exchangeable shares)
• special considerations when planning for sale of investment (minimizing Canadian tax on gains)
33
Financing & Inbound Investment: Acquisitions
Illustration of Inbound Acquisition Planning
Pre-Acquisition
Bidco
Foreign Parent
EquityFMV/PUC/Cost = $120
$180debt
$300
Canada
Shareholders
FMV = $300PUC = $80
Canco
FMV = $210Cost = $85
FMV = $90CCDE/CCEE = $45
ForeignSubsidiary
CanadianMine
ForeignMine
34
Financing & Inbound Investment: Acquisitions
Post-Acquisition
Foreign lender/shareholderlocated in appropriate taxTreaty country regardingInterest/dividends/gains
Foreign Parent
Foreign Holdco
Bidco(post-amalgamation)
EquityFMV/PUC/Cost = $120
$180Debt
Canada
Bidco/Canco mergerconsolidates interestexpense with operatinginterest income
FMV = $210Cost = $210
ForeignSubsidiary
ForeignMine
ForeignMine
FMV = $90CCDE/CCEE = $45Cost of bump-
Eligible propertyincreased
Planning to use targetlosses and managesuccessor rules
Use of foreign holdcoprovides flexibility onsale
Bidco debt/equityoptimized regardingthin cap
Consider pre-acquisitionPlanning for bump-eligibleproperty
Shareholders
$300
35
Financing & Inbound Investment: Acquisitions
For more on acquisitions of Canadian mining corporations see:
• www.miningtaxcanada.com/mergers-acquisitions/
• “Using Exchangeable Shares in Inbound Canadian Transactions” (About page of website)
• “Canada’s Tax Cost Step-Up: What Foreign Purchasers Should Know” (About page of website)
• “Canada’s Section 116 System for Non-Resident Vendors of Taxable Canadian Property” (included with materials)
36
Exit Strategies
The time to plan for how to exit an investment in Canadian mining is before making the investment, especially for non-residents. Careful planning can help minimize:
• Canadian capital gains tax
• Canadian s.116 obligations
• home-country taxation (direct and CFC)
Taxpayers are invariably more successful with planning that is put in place at the time the investment is made as opposed to planning done near the time of sale
37
Exit Strategies: Debt
Unless somehow convertible into or exchangeable for another property, a debt investment into Canada will generally not constitute “taxable Canadian property” so as to be subject to Canadian capital gains tax or s.116 obligations
• simply lending to a Canadian mining company does not create TCP
But consider the potential for s.214(7) to create Part XIII tax on sale or redemption if proceeds exceed issue price and debt is not an “excluded obligation”
38
Exit Strategies: Equity
When making an equity investment in Canada, the three principal Canadian tax considerations are:
• will the investment constitute TCP, so as to be subject to Canadian capital gains tax
• if so, can protection from Canadian capital gains tax be found in a relevant tax treaty
• if the investment constitutes TCP, do the parties have obligations under the s.116 system governing dispositions of TCP by non-resident vendors
39
Exit Strategies: Equity
Taxable Canadian Property• includes interest in Canadian real property or Canadian resource
property (which includes most mining royalties)• property used or held in a business carried on in Canada• share not listed on a designated stock exchange (other than of a
mutual fund corporation) or partnership interest or trust interest (other than of a mutual fund trust), that derives its value (directly or indirectly) primarily from Canadian real/resource properties anytime in the preceding 60 months (other than through a corporation, partnership or trust whose shares/interests are not TCP)
• share that is listed on a designated stock exchange, or of a mutual fund corporation, or interest in a mutual fund trust, if at any time in the preceding 60 months both:
• more than 50% of the share’s/interest’s FMV was derived (directly or indirectly/ from Canadian real/resource properties; and
• taxpayer (together with non-arm’s length persons) owned 25%+ of corporation’s shares or MFT’s units
40
Property TCP Status
Shares of corporations listed on a designated stock exchange; shares of mutual fund corporations; units of mutual fund trusts
TCP if at any time during the preceding 60 months, both1. the nonresident holder owned more than 25 percent of any class of the corporation’s shares or the trust’s units (including any shares or units owned by non-arm’s length persons), and2. more than 50 percent of value of the shares or units was derived (directly or indirectly) from Canadian real property
Unlisted shares of corporations (other than mutual fund corporations); interests in partnerships and most trusts
TCP if at any time during the preceding 60 months more than 50 percent of value of the share or interest was derived from Canadian real property directly or indirectly (otherwise than through a corporation, partnership or trust the shares or interests of which are not themselves TCP at that time)
Exit Strategies: Equity
Summary: TCP Status
41
Exit Strategies: Equity
Determination of taxable Canadian property status for shares
2010 Budget narrowed TCP status for shares: only TCP if shares derive value primarily from Canadian real property in past 5 years (directly or indirectly)
Previously, CRA had allowed taxpayers to make “value primarily derived” determination based on (1) corporation’s gross assets, or (2) corporation’s net assets, allocating liabilities on a reasonable basis
42
Exit Strategies: Equity
At 2011 CTF Round Table, CRA announced a change in its administrative policy
1. For property held by the taxpayer any time during 2011 and disposed of before 2013, old policy applies
2. For all other property, the CRA will make “value primarily derived” determination based on gross assets
Q: shouldn’t the value of a share be based on the value of the corporation’s assets less all claims ranking ahead of the shares, i.e., on a net assets basis?
43
Exit Strategies: Equity
Tax Treaties: where the Canadian equity investment will (or may in the future) constitute TCP, it is essential to consider whether tax on sale could be reduced either by
• structuring the exit as a dividend for Canadian tax purposes (if dividend withholding tax is less than Canadian capital gains tax), or
• using a tax treaty to achieve a more favourable result, taking into account (1) Canadian taxation of the gain, (2) taxation of the gain in the shareholder’s jurisdiction, (3) costs of
distributing the sale proceeds out of the shareholder’s jurisdiction (whenever this occurs) and (4) taxation of that distribution in the jurisdiction of the ultimate parent
44
Exit Strategies: Equity
Tax Treaties: there is a very wide range of protection from Canadian capital gains taxation on a sale of shares in Canada’s tax treaties (see “Canadian Taxation of Mining,” included with materials) – for example:
No relief (e.g., Chile. ,Argentina, Brazil, Australia, Japan, India)
Taxation if share value derived primarily from Canadian real property (e.g., China, Singapore, Korea, Ireland)
As above, but operating mines excluded from “real property” (e.g., Netherlands, Germany, South Africa, Luxembourg, Switzerland, U.K.)
Taxation limited to Canadian corporations (Netherlands, Russia, Switzerland, U.S., Germany)
Publicly-listed shares excluded (Luxembourg, Netherlands, U.K., Germany, Switzerland)
Minimum ownership threshold, usually 10% (South Africa, U.K., Netherlands, Luxembourg, Switzerland)
45
Exit Strategies: Equity
Tax Treaties
Residence:mind and management is not in jurisdiction of entity’s governing law
Agency: entity is acting as agent for someone else
Beneficial Ownership: entity is not the beneficial owner of the relevant property
Sham: purported legal relationships do not in fact exist
Treaty Shopping: use of treaty jurisdiction somehow inherently abusive
46
Exit Strategies: Equity
s.116 System: applicable to dispositions of TCP by a non-resident (whether or not any tax is owing or any gain exists), unless an exception applies; consists of
• vendor notification obligation
• purchaser remittance obligation
• vendor tax return filing obligation
See “Canada’s Section 116 System for Non-Resident Vendors of Taxable Canadian Property” (included with materials)
47
Exit Strategies: Equity
s.116 System: Excluded Property
Generally no s. 116 system obligations arise to the extent the TCP is “excluded property,” which includes:
• shares listed on a recognized stock exchange
• deemed TCP (e.g., shares received on a tax-deferred rollover)
• bonds, debentures, mortgages and similar obligations
• options/interests in respect of the foregoing
• “treaty-exempt property” (which requires the purchaser to notify the CRA within 30 days of sale if the purchaser and vendor are related)
48
Exit Strategies: Equity
s.116 System: Vendor notification obligation
Vendor is required to notify the CRA within 10 days of the disposition, unless the TCP is (1) excluded property, or (2) property described in s.116(5.2), viz., property that may yield income on disposition
s.116 System: Vendor Tax Return Obligation
Vendor is required to file a Canadian tax return, unless all TCP dispositions in the year are (1) of excluded property, or (2) ones in respect of which the CRA issued a certificate of compliance
49
Exit Strategies: Equity
s.116 System: Purchaser remittance obligation
Purchaser is liable to remit to the CRA (and may withhold from the purchase price) 25% of the purchase price, unless
• property is excluded property;
• purchaser reasonably believes that vendor is not a non-resident, after making reasonable inquiry;
• requirements for s.116(5.01) “treaty protected property” exception are met; or
• CRA has issued a certificate of compliance
50
Exit Strategies: Equity
s.116 Withholding: Treaty-protected property exception
Where a non-resident vendor is claiming to be exempt from tax on a disposition of TCP due to a treaty exemption, purchaser can1. withhold and remit;2. demand a certificate of compliance; or3. file Form T2062C within 30 days of sale under s. 116(5.01)
Problem with 3. was that s.116(5.01), which was introduced in 2008, does not exempt the purchaser from liability if treaty exemption does not in fact apply (e.g., due to valuation uncertainty, chattel/fixture uncertainty, former residence, limitation on benefits, anti-avoidance, etc.)
➙ Result: Purchasers often unwilling to rely on 3.
51
Exit Strategies: Equity
s.116 Withholding: Treaty-protected property exception
Statement on CRA website (“Disposing of or acquiring certain Canadian property”) now provides that CRA will generally not assess a purchaser for not withholding in good-faith belief that non-resident was treaty-exempt if• purchaser has filed Form T2062C;• purchaser and vendor are unrelated; and• purchaser has made every reasonable effort to determine that property is treaty-exempt“Every reasonable effort” means at least the steps suggested on Form T2062C
52
Canada-U.S. Treaty Issues: Limitation on Benefits
Canada’s treaty with the U.S. is the only Canadian tax treaty that contains a comprehensive “limitation on benefits” (LOB) Article, restricting who may claim benefits under the Treaty (it is not enough just to be a U.S. resident)
U.S. subsidiaries of foreign corporations generally do not qualify under the base test
See “Thoughts on the New LOB Clause in The Canada-U.S. Treaty” (included with materials)
53
Canada-U.S. Treaty Issues: Limitation on Benefits
Is person seeking treaty
benefits a U.S. resident
for treaty purposes?
Yes
Is U.S. resident a qualifying person?
No
Are benefits available under “active trade or
business exception”?
No
Treaty benefits available only if
“derivative benefits” test met (limited
benefits only) or under residual exception in Article XXIX-A(6).*
Yes YesNo
Not eligible for treaty benefits.
Eligible for treaty
benefits.*
Eligible for treaty
benefits.*
* Availability of treaty benefits subject to antiabuse rules as per Article XXIX-A (7).
Limitation on Benefits: Summary of Analysis
54
Canada-U.S. Treaty Issues: Limitation on Benefits
Basic test: is the U.S. resident claiming Treaty benefits a “qualifying person”?
1. natural person
2. corporation whose principal class of shares primarily traded on recognized Canadian or U.S. stock exchange
3. corporation more than 50% of whose shares (by votes and value) are owned by 5 or fewer persons described in 2 (directly or indirectly
through a chain of qualifying persons)
4. corporation 50% or more of whose shares (by votes and value) are not owned (directly or indirectly) by non-qualifying persons
55
Canada-U.S. Treaty Issues: Limitation on Benefits
Is person seeking treaty
benefits a U.S.
resident for treaty
purposes?
Yes
Is the U.S. resident (or
related person) actively
conducting a trade or
business in the U.S.
(other than an ineligible business)?*
Is the U.S. trade or business substantial
relative to the activity carried on in Canada
giving rise to the income on which the U.S. resident is seeking treaty
benefits?
U.S. resident entitled to
treaty benefits with respect to connected or incidental
income, subject to antiabuse limitations.
No
Active trade or business
exception not available.
Active trade or business
exception not available.
Active trade or business
exception not available.
* An ineligible business is the making or managing of investments, unless carried on with customers in the ordinary course of business by a bank, insurance company, registered securities dealer, or deposit-taking financial institutions.
Is the Canadian-source income
derived in connection with or incidental to the
U.S. trade or business (directly
or indirectly through one or more Canadian
residents)?
Active trade or business
exception not available.
Yes Yes Yes
NoNo
No
Active Trade or Business (ATB) Test Summary
56
Canada-U.S. Treaty Issues: Limitation on Benefits
Is person seeking treaty
benefits a U.S.
resident for treaty
purposes?
Yes
Are 90% + of U.S. company’s shares* owned,
directly or indirectly, by
qualifying persons or
eligible third-country
shareholders?**
Are U.S. company’s eligible
third-country shareholders
entitled to Canadian tax rate
on the relevant income as low or
lower than the corresponding rate under the
treaty?
U.S. company entitled to
treaty benefits under Articles X (Dividends), XI (Interest),
and XII (Royalties), subject to antiabuse limitations.
No
Not eligible for derivative benefits.
Not eligible for derivative benefits.
Not eligible for derivative benefits.
•“Debt substitute shares” are ignored under this test, and a further test applies if a “disproportionate class of shares” exists.
** An eligible third-country shareholder is a resident of a third country entitled to full benefits under a treaty between Canada and that third country, and who (if resident in the U.S.) would either be a qualifying person under the Canada–U.S. treaty or eligible for treaty benefits under the “active trade or business” test (if it was assumed that the shareholder carried on in the U.S. the same business it in fact carries on in the third country).
Does U.S. company meet base erosion
test (deductible expenses payable to
non-qualifying persons < 50%
of gross income)?
Not eligible for derivative benefits.
Yes Yes Yes
No
No
No
Derivative Benefits Test Summary
57
Canada-U.S. Treaty Issues: LLCs
For many years, Canada refused to extend Treaty benefits to LLCs that are disregarded for U.S. tax purposes, on the basis that they were not U.S. residents (liable to pay tax in the U.S.), and would not look through them (like partnerships) to allow the LLC members to claim Treaty benefits
CRA continued this position in spite of Tax Court decision in TD Securities LLC v. The Queen holding the taxpayer LLC to be entitled to Treaty benefits
Article IV(6) (added by the 2007 Protocol) addresses this, by allowing Treaty benefits to be claimed by U.S. residents (only) on items of income earned through a disregarded LLC
58
Canada-U.S. Treaty Issues: Anti-Hybrid Rules
Unlimited Liability Corporations (ULCs): popular with U.S. companies investing in Canada, because they can elect to disregard the ULC for U.S. tax purposes
Under Article IV(7)(b) of the Canada-U.S. Tax Treaty, Treaty benefits are denied where U.S. taxation is different as a result of the ULC being disregarded for U.S. tax purposes➙ 25% Canadian withholding tax instead of 0% (interest) or 5% (dividends)➙ especially problematic on payments from ULC to LLC
There are work-arounds, but use disregarded ULCs with caution
59
Canada-U.S. Treaty Issues: Anti-Hybrid Rules
Article IV(7)(b)
An amount of income, profit or gain shall be considered not to be paid to or derived by a person who is a resident of a Contracting State where:
(a) The person is considered under the taxation law of the other Contracting State to have derived the amount through an entity that is not a resident of the first-mentioned State, but by reason of the entity not being treated as fiscally transparent under the laws of that State, the treatment of the amount under the taxation law of that State is not the same as its treatment would be if the amount had been derived directly by that person; or
(b) The person is considered under the taxation law of the other contracting State to have received the amount from an entity that is a resident of that other
State, but by reason of the entity being treated as fiscally transparent under the laws of the first-mentioned Sate, the treatment of the amount under the taxation law of that State is not the same as its treatment would be if that entity were not treated as fiscally transparent under the laws of that State.
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Canada-U.S. Treaty Issues: Anti-Hybrid Rules
LLC Owning Shares of Disregarded ULC
CRA says the better view is thatU.S. residents cannot claim Treatybenefits on amounts paid by a ULCto an LLC where both entities areand the income item disregardedfor U.S. tax purposes: see CRAdocument 2009-0345351C6, datedFebruary 11, 2010
Consider inserting a third country(i.e., Luxembourg) between LLCand ULC, so that a different treatyapplies
U.S.
Canada
U.S. Residents
LLC
ULC
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Canada-U.S. Treaty Issues: Anti-Hybrid Rules
Dividends Paid by Disregarded ULCs
U.S. Corp
U.S.
CAN
Dividends
U.S. Corp
U.S.
CAN
Base Case 2 - Step Work-Around
ULC ULC
Step 2. Return of PUC Distribution
CRA document 2009-0348581R3
Step 1. ULC PUC increase (deemed dividend for Canadian purposes)
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Canada-U.S. Treaty Issues: Anti-Hybrid Rules
Disregarded ULCs and Interest
USCo
100%
USCoULC
Interest-Bearing Loan
Base Case
25% InterestWithholding
USCo
USSub
USSubULC
Interest-Bearing Loan
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Canada-U.S. Treaty Issues: Anti-Hybrid Rules
Disregarded ULCs and Interest
USCo
USSub
USSubULC
Interest-Bearing Loan
90%
10%
Alternative 2: PartnershipCRA document 2009-0318491I7
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The End
Thank you
For more on the Canadian taxation of mining, go to www.miningtaxcanada.com
Steve SuarezBorden, Ladner Gervais LLP (Toronto)