On December 10, 2008, the Advisory Panel on Canada’s System of International Taxation delivered its lengthy final report and recommendations for change to the Canadian Minister of Finance. The Panel was established by the Canadian Government in November, 2007 following on the 2007 Budget initiative to study Canada’s international tax system. The Panel released its first report in April, 2008 in the form of a Consultation Paper outlining various considerations for change, and in response received numerous submissions from interested parties.
In the eagerly awaited report, the Panel has made key recommendations in the context of both inbound and outbound direct investment. The Panel notes that its recommendations “seek not to reform but rather to improve” Canada’s existing international system which has “served Canada well”. Due to the current economic climate (which has changed significantly since the Panel was instituted), the Panel has focused on changes which should be fiscally neutral to the government.
In the inbound direct investment context, the Panel recommends the following key changes:
- Maintaining the current thin capitalization regime, but reducing the permitted debt-to-equity ratio from 2:1 to 1.5:1 and extending its application to partnerships, trusts and Canadian branches of non-resident corporations;
- Discouraging tax-motivated debt-dumping arrangements within related corporate groups “while ensuring bona fide business transactions are not affected”; and
- Considering further withholding tax reductions in future bilateral tax treaties and protocols “to the extent permitted by the government’s fiscal framework and its agenda regarding additional corporate tax rate reductions”.
The Panel’s recommendations for change in the outbound direct investment context include:
- Broadening the existing partial exemption system to cover all foreign active business income earned by foreign affiliates, and extending it to capital gains and losses realized on the disposition of shares of a foreign affiliate where those shares derive their value from active business assets;
- Reviewing the criteria for “foreign affiliate” status and the scope of the base erosion and investment business rules in the foreign affiliate regime;
- Reviewing and undertaking consultation on how to reduce overlap and complexity in the anti-deferral (foreign affiliate, foreign investment entity and non-resident trust) regimes while ensuring all foreign passive income is taxed on a current basis; and
- Repealing the double-dip financing rules in section 18.2 of the Income Tax Act, and not imposing any additional rules to restrict interest deductibility on borrowed funds used to invest in foreign affiliates.
The Panel has also made several significant recommendations to simplify administration and compliance with Canada’s international tax system, including:
- Eliminating Regulation 102 and 105 withholding requirements for services and employment performed in Canada where the non-resident certifies the income is exempt under a tax treaty with Canada;
- Eliminating section 116 withholding requirements where the non-resident certifies that a gain from the disposition of taxable Canadian property is exempt from Canadian tax under a tax treaty with Canada;
- Exempting the sale of all publicly traded Canadian securities from the section 116 certification and withholding requirements.
A copy of the Advisory Panel’s final report and executive summary is available on the Panel’s website at: http://www.apcsit-gcrcfi.ca/07/index-eng.html