The Canada Revenue Agency (CRA) recently indicated that Barbados “exempt insurance companies” (EICs) may be considered “liable to tax” in Barbados within the meaning of Article IV of the Canada-Barbados tax treaty.1 This new position on EICs is important, as it now confirms that active business income earned by a Barbados EIC may generally be repatriated to Canada free of Canadian tax despite being subject to a very low amount of tax in Barbados. The new CRA view also assists in interpreting the tax treatment of income earned by subsidiaries in other foreign jurisdictions.
An EIC is a company licensed under the Barbados Exempt Insurance Act (BEIA) to carry on an “exempt insurance business,” which is the business of insuring risks located outside Barbados in respect of which premiums originate outside Barbados. An EIC that is resident in Barbados under the common law test of “central management and control” is liable to tax on its worldwide income under the Barbados Income Tax Act (BITA). However, the BEIA generally exempts EICs from tax on their income derived from an exempt insurance business conducted in Barbados. As a result, an EIC is generally subject to a licence fee or tax under the BEIA at a maximum amount of BD$5,000 per year for a period of 30 years.
Canada’s Foreign Affiliate Rules
Under the Income Tax Act (Canada) (the Act), “exempt surplus” dividends from a foreign affiliate may generally be received by a Canadian corporate shareholder free of Canadian tax. The active business earnings generated by the affiliate in Canada, or in a country with which Canada has entered into a comprehensive tax treaty or tax information exchange agreement (a designated treaty country), may generate exempt surplus, but only if the foreign affiliate is “resident” in a designated treaty country.
Residence for purposes of the Act is generally determined by the common law central management and control test (which is generally determined by where the board of directors meets and makes their decisions). However, in order to qualify for the “exempt surplus” regime, a foreign affiliate must be resident in the particular country under this common law test, and for tax treaty countries (but not tax information exchange agreement countries), must also satisfy one of the following conditions:
- The foreign affiliate must be a resident of the particular country for the purpose of Canada’s tax treaty with that country;
- The foreign affiliate would have been a resident of that country for the purpose of Canada’s tax treaty with that country if the affiliate were treated as a corporation under the tax laws of that country;
- Where the applicable tax treaty entered into force before 1995, the foreign affiliate would have been a resident of that country for the purpose of that treaty but for a provision in the treaty that has not been amended after 1994 and that provides that the treaty does not apply to the affiliate; or
- The foreign affiliate would be a resident of that country under one of the first three conditions if the applicable tax treaty had entered into force.
The Canada-Barbados Tax Treaty
The Canada-Barbados tax treaty was entered into in 1980 and has not been amended. Similar to most other bilateral tax treaties, the Canada-Barbados tax treaty generally defines a “resident” of a contracting state (i.e., Canada or Barbados) in Article IV to mean a person who, under the law of that state, is liable to tax therein by reason of his domicile, residence, place of management or any other criterion of a similar nature. Pursuant to Article XXX of the treaty, however, the treaty does not apply to companies entitled to any special tax benefit under the Barbados International Business Companies (Exemption from Income Tax) Act, Cap. 77 or any similar law enacted by Barbados.
CRA Administrative Position
The CRA’s historical position was that a Barbados EIC was not “liable to tax” within the meaning of Article IV of the Canada-Barbados tax treaty, and as such was entitled neither to the benefits of the treaty nor to exempt surplus treatment in respect of any dividends paid out of active business earnings.2 The CRA’s former view was that an EIC was effectively exempt from taxation in Barbados for a guaranteed period of 30 years (aside from a nominal tax that CRA viewed as being essentially an annual licensing fee), and as such was not subject to the most comprehensive form of taxation of a person under the law of Barbados.
We understand that the CRA’s position with respect to EICs has been under review for some time. In 2007, the CRA released a general statement (ITTN #35) regarding the level of taxation a jurisdiction must levy on a person’s income before that person would be considered “liable to tax” under a tax treaty.3 In ITTN #35, the CRA accepted that there may be situations where a person’s worldwide income is subject to a contracting state’s full taxing jurisdiction, despite the fact that the state’s domestic law does not levy tax on the person’s taxable income or taxes it at low rates. In these cases, the CRA suggested that it would generally accept that the person is a resident of the relevant contracting state unless the arrangement is abusive.
In the recent technical interpretation , the CRA applied the approach set out in ITTN #35 to the Canada-Barbados tax treaty and Barbados EICs, concluding that an EIC that is resident in Barbados under the common law test4 is “liable to tax” in Barbados within the meaning of Article IV(1) of the treaty notwithstanding that it is eligible for a time-limited exemption from actual taxation at normal rates on its exempt insurance business income. The CRA asserted, however, that a Barbados-resident EIC is not entitled to the benefits of the Canada-Barbados tax treaty by reason of Article XXX, as, in the CRA’s view, the BEIA is legislation that is similar to the Barbados International Business Companies (Exemption from Income Tax) Act.
For purposes of Canada’s foreign affiliate rules, the CRA concluded that an EIC that is resident in Barbados under the common law central management and control test is resident in a designated treaty country (Barbados) by reason of the third condition enumerated above – that is, because the Canada-Barbados tax treaty entered into force before 1995, and the EIC would be a resident of Barbados for the purpose of the treaty but for Article XXX. Therefore, the CRA’s former view that the Barbados EIC cannot qualify for exempt surplus treatment is no longer applicable, and the CRA now accepts that active business income earned by a Barbados-resident EIC in a designated treaty country generates exempt surplus.
Relief to be Provided
For dividends received by a Canadian corporation from an EIC before February 26, 2007 (the date of publication of ITTN #35) and assessed as having been paid out of the EIC’s taxable surplus, the CRA said that it will provide relief in accordance with its new interpretation of Article IV of the Canada-Barbados tax treaty only if there is a valid objection or appeal outstanding regarding the treatment of the dividend. For dividends received by a Canadian corporation on or after February 26, 2007 and reported or assessed as having been paid out of taxable surplus, the CRA will permit the shareholder to amend its return for the relevant year within the normal reassessment period.
The CRA’s new position with respect to the treatment of Barbados EICs is a welcome development that is consistent with the context and purpose of the Act and the foreign affiliate regime. The new position is also consistent with the CRA’s position on treaty residence generally as expressed in ITTN #35. In addition, the new position is consistent with Canada’s tax policy that allows exempt surplus to be earned in countries with which Canada has entered into a comprehensive “tax information exchange agreement” that has entered into force. Specifically, many of the nine countries that have entered into tax information exchange agreements with Canada generally impose no or nominal income taxes, and will be treated as “designated treaty countries” once those agreements enter into force. It would be inconsistent to allow exempt surplus to be earned in those countries while denying the ability to earn exempt surplus in Barbados – a country with which Canada has an actual tax treaty – simply because the entity is exempt from tax or is taxed at very low rates in that country. Although the CRA has indicated that its new position is applicable in limited circumstances with respect to earnings that have already been paid out as dividends, this position should apply to all historic earnings of Barbados EICs that have not yet been distributed to Canada.