Canada's Finance Minister James Flaherty tabled the government's 2014 federal budget on February 11 2014. According to Budget 2014, the government is on track to return to balanced budgets in 2015. In keeping with commitments made at the beginning of the economic recovery, the government has focused on making itself more efficient by controlling direct programme spending by federal departments, rather than raising taxes that are harmful to job creation and economic growth.
Among the tax measures proposed in Budget 2014 are a number of international tax measures, which are discussed below. The government's intentions in introducing these measures are to improve the fairness and integrity of the tax system.
Budget 2014 proposes to amend the anti-avoidance rule in the foreign accrual property income (FAPI) regime relating to the insurance of Canadian risks. The FAPI regime generally requires that income from property earned by, and income from certain businesses carried on by, a controlled foreign affiliate of a taxpayer resident in Canada be included in the taxpayer's income on an accrual basis.
Under current rules, a specific anti-avoidance rule in the FAPI regime provides that income from the insurance of Canadian risks is FAPI where 10% or more of the gross premium income (net of reinsurance ceded) of a foreign affiliate of the Canadian taxpayer in respect of all risks insured by the affiliate is premium income from Canadian risks. However, some taxpayers have entered into sophisticated tax-planning arrangements (sometimes known as 'insurance swaps') designed to get around this rule. These arrangements generally involve transferring Canadian risks, originally insured in Canada, to a wholly owned foreign affiliate of the taxpayer. The Canadian risks are then exchanged with a third party for foreign risks that were originally insured outside of Canada, while at the same time ensuring that the affiliate's overall risk profile and economic returns are essentially the same as they would have been had the affiliate not entered into the exchange.
Budget 2014 will amend the anti-avoidance rule in the FAPI regime relating to the insurance of Canadian risks to clarify that the rule applies where:
- taking into consideration one or more agreements or arrangements entered into by the foreign affiliate, or by a person or partnership that does not deal at arm's length with the affiliate, the affiliate's risk of loss or opportunity for gain or profit in respect of one or more foreign risks can – or could, if the affiliate had entered into the agreements or arrangements directly – reasonably be considered to be determined by reference to the returns from one or more other risks that are insured by other parties; and
- at least 10% of the foregoing risks are Canadian risks.
If the anti-avoidance rule applies, the foreign affiliate's income from the insurance of the foreign risks and any income from a connected agreement or arrangement will be included in computing its FAPI. This measure will apply to taxation years of taxpayers that begin on or after February 11 2014.
Budget 2014 proposes to add new conditions to qualify for the regulated foreign financial institution exception from the definition of 'investment business' under the FAPI rules. While income from an investment business carried on by a foreign affiliate of a taxpayer is included in the affiliate's FAPI, most financial services businesses are not considered investment businesses under certain legislative exceptions.
One such exception is the regulated foreign financial institution exception. The government is concerned that Canadian taxpayers that are not financial institutions may use this exception to carry on investment activities for their own account rather than for third-party customers, without paying Canadian tax on their investment profits. Such taxpayers often access the exception by establishing a foreign affiliate that is made subject to regulation under foreign banking and financial laws and carries on the investment activities.
The proposed conditions will effectively restrict the availability of this exception to regulated Canadian financial institutions with significant capital deployed in Canada. Specifically, the new conditions will require the Canadian taxpayer:
- to be a regulated financial institution (ie, a Canadian resident that is a Schedule I bank, trust company, credit union, insurance corporation or securities trader whose activities are regulated by the Office of the Superintendent of Financial Institutions or a similar provincial regulator); and
- to satisfy certain minimum capitalisation requirements (at least 50% of the "total taxable employed in Canada" of the Canadian resident and related Canadian corporations must be attributable to taxable capital employed in Canada of regulated Canadian financial institutions or, for banks, trust companies or insurance corporations, total equity of at least $2 billion).
In addition, the old requirements that the foreign affiliate carry on a regulated foreign financial services business and the proprietary activities comprise part of that business will continue to apply.
Budget 2014 notes that the government will continue to monitor developments in this area. The proposal will apply to taxation years of taxpayers that begin after 2014, with stakeholders being invited to submit comments concerning its scope within 60 days after February 11 2014.
Budget 2014 proposes to add a specific anti-avoidance rule that would apply for both the thin capitalisation provisions and the Part XIII withholding tax provisions imposed on interest paid to non-arm's length non-residents. This rule is intended to prevent a taxpayer from circumventing the provisions through the use of back-to-back loan arrangements. These arrangements generally involve interposing a third party (eg, a foreign bank) between two related taxpayers (eg, a foreign parent corporation and its Canadian subsidiary) in an attempt to avoid the rules that would apply if a loan were made directly between the two related taxpayers.
Specifically, Budget 2014 proposes that a back-to-back loan arrangement will exist where – as a result of a transaction or series of transactions – a taxpayer has an outstanding interest-bearing obligation owing to a lender (the intermediary), and the intermediary or any person that does not deal at arm's length with the intermediary:
- is pledged a property by a non-resident person as security in respect of the obligation (by itself a guarantee will not be considered a pledge of property);
- is indebted to a non-resident person under a debt for which recourse is limited; or
- receives a loan from a non-resident person on condition that a loan be made to that taxpayer.
If a back-to-back loan arrangement exists, the Canadian taxpayer will generally be deemed to owe an amount to the non-resident person. This taxpayer will also be deemed to have an amount of interest paid or payable to the non-resident person. The result is that the Canadian taxpayer could be denied an interest deduction under the thin capitalisation provisions and would also be required to withhold withholding tax on the deemed interest income. The non-resident person and the Canadian taxpayer will be jointly and severally (or solidarily) liable for the additional Part XIII withholding tax.
This measure will apply, in respect of the thin capitalisation provisions, to taxation years that begin after 2014; and in respect of Part XIII withholding tax, to amounts paid or credited after 2014.
In Budget 2013, the government announced a public consultation on 'treaty shopping'. Later in 2013 the government released a consultation paper and received a number of submissions from stakeholders. In July 2013 the Organisation for Economic Cooperation and Development (OECD) issued an action plan to address the issue of aggressive tax planning by multinational enterprises, known as 'base erosion and profit shifting'. The government has indicated that the OECD's recommendations in this regard will be relevant in developing a Canadian approach to address treaty shopping.
In Budget 2014, the government has proposed a rule to prevent treaty shopping. The rule is intended to address arrangements identified as an improper use of Canada's tax treaties in the consultation paper, and uses a general approach focused on avoidance transactions. The proposed rule would include provisions that relate to:
- a main purpose test;
- a conduit presumption;
- a safe harbour presumption; and
- a relieving measure if it would be reasonable in the circumstances.
The government proposes to add the rule to the Income Tax Conventions Interpretation Act so that it would apply in respect of all of Canada's tax treaties, and would apply to taxation years that commence after its enactment.
Interested parties are invited to provide comments within 60 days after February 11 2014 on the proposed rule (and any appropriate transitional relief), as well as on five examples provided setting out the intended application of the proposed rule to the following situations:
- assignment of income;
- payment of dividends;
- change of residence;
- bona fide investments; and
- safe harbour for an active business.
The government announced in Budget 2014 that it is seeking input from stakeholders on issues raised by the OECD's base erosion and profit shifting action plan, and is inviting comments from interested stakeholders "to help inform Canada's participation as a member of the OECD in considering options to increase the fairness and effectiveness of international tax rules". The action plan recommended 15 specific action items with accompanying timelines. The action items are directed at:
- hybrid entity and hybrid instrument mismatches;
- ensuring that transfer-pricing outcomes are in line with value creation;
- improving information-gathering methodology and requiring taxpayers to disclose aggressive tax planning arrangements;
- addressing the tax challenges of the digital economy;
- related-party financing arrangements; and
- harmful tax practices and tax treaty abuse.
Budget 2014 invites stakeholders to comment on those action items –in particular, how to ensure fairness among different categories of taxpayers (eg, multinational enterprises, small businesses and individuals), and how to better protect the Canadian tax base, while maintaining an internationally competitive tax system that is attractive for investment. The government has asked for input on five general questions:
- What are the impacts of international tax planning by multinational enterprises on other participants in the Canadian economy?
- Which of the international corporate income tax and sales tax issues identified in the action plan should be considered the highest priorities for examination and potential action by the government?
- Are there other corporate income tax or sales tax issues related to improving international tax integrity that should be of concern to the government?
- What considerations should guide the government in determining the appropriate approach to take in responding to the issues identified – either in general or with respect to particular issues?
- Would concerns about maintaining Canada's competitive tax system be alleviated by coordinated multilateral implementation of base protection measures?
In addition, the government is inviting input from stakeholders on what actions it should take to ensure the effective collection of sales tax on e-commerce sales to Canadian residents by foreign-based vendors, including whether it should adopt the approach taken by other countries and require foreign-based vendors to register with the Canada Revenue Agency and charge goods and services tax/harmonised sales tax if they make e-commerce sales to Canadian residents.
The government has invited interested parties to submit comments within 120 days after February 11 2014.
For further information on this topic please contact Stephen J Fyfe, Richard J Bennett, Daniel Lang or Stephanie Wong at Borden Ladner Gervais LLP by telephone (+1 416 367 6000), fax (+1 416 367 6749) or email (firstname.lastname@example.org, email@example.com, firstname.lastname@example.org or email@example.com). The Borden Ladner Gervais website can be accessed at www.blg.com.