The controversies which have surrounded Canada’s attempts since 1999, to design a tax regime which will apply to foreign portfolio investments made by Canadian taxpayers and the parallel increase in attention by Canada to foreign constituted trusts, when both business and tax considerations are factored in, has led foreign investment managers increasingly to structure investment funds in the form of publicly traded or private partnerships. These investment funds are generally formed outside of Canada and have no investments in Canadian situated assets. Such vehicles are attractive to Canadian investors seeking to diversify their portfolio holdings.
Managers of foreign investment funds must, however, carefully monitor the level of Canadian investment in these funds if they are to avoid exposure to Canadian reporting requirements.
Under the Canadian taxing legislation, a “reporting entity” for a fiscal period is required to file with the Canadian tax authorities for that period a prescribed form setting out basic details about the entity, the type of foreign property owned, and the income derived from that property. A prescribed form (T1135) is provided by the Canadian taxation authorities for this purpose.
For a reporting entity that is a partnership, the T1135 return must be filed (i) for a partnership all the partners of which are corporations throughout the fiscal period of the partnership, within 5 months of the end of the partnership’s fiscal period; (ii) for a partnership all the partners of which are individuals throughout the fiscal period of the partnership, on or before the last day in March in the calendar year immediately following the calendar year in which the fiscal period ends, and (iii) for any other partnership, on or before the earlier of (A) the day that is 5 months after the end of the fiscal period of the partnership, and (B) the last day in March in the calendar year immediately following the calendar year in which the fiscal period ends. In certain cases where an individual is a direct or indirect member of a partnership, the fiscal period of the partnership (for Canadian tax purposes) must correspond to the calendar year.
A “reporting entity” for a fiscal period is defined as a “specified Canadian entity” for that period where, at any time (other than a time when the entity is non-resident) in the period, the aggregate cost amount to the entity of “specified foreign property” of the entity exceeds Cdn $100,000. A partnership will be a specified Canadian entity for a fiscal period if the aggregate share of the income or loss of the partnership for the period allocable to non-resident members is less than 90% (in other words, if Canadian residents are entitled to allocations of more than 10% of the income or loss of the partnership). A partnership, all of the members of which are certain types of Canadian residents (e.g. mutual fund trusts, tax-exempt organizations), will not be a specified Canadian entity and will therefore not be subject to the reporting requirements.
Although the reporting entity definition excludes periods during which specified Canadian entities are non-resident, this may not be helpful in the partnership context as, for Canadian tax purposes, it is not at all clear how, if at all, the concept of residence would apply to partnerships. Moreover, the manner in which the reporting rules are worded and the absence of any rules which support a determination of residence status for partnerships in the context of these rules leaves uncertainty as to whether partnerships, which are not generally considered to be moral persons to which residence would attribute under Canadian domestic law principles, are intended to report if their assets exceed the specified foreign property threshold. We understand, from discussions with the Canadian revenue authorities, that the government administrative position is that foreign-constituted partnerships with Canadian partners in excess of the 10% level, must fulfill the reporting requirements.
As noted above, in order to be a reporting entity for a fiscal period, the aggregate cost amount of “specified foreign property” held by the entity in that period must exceed Cdn $100,000. The instructions to T1135 provide a summary of the types of properties that constitute “specified foreign property”. Specifically, an interest in a partnership (that is not a specified Canadian entity) would constitute “specified foreign property”. This is relevant if a partnership invests in other partnerships (“investee partnerships”). If an investee partnership is itself a specified Canadian entity, then an interest in that investee partnership would not be “specified foreign property” as that the investee partnership would instead be required to report in its own right if ownership and property thresholds are such as would bring it within the ambit of the reporting rules.
The Canadian taxing legislation imposes a maximum penalty of $2,500 in respect of a failure to file any required information return, which would include a T1135 return. An additional penalty equal to $500 for any month in which a T1135 return should have been filed and has not been filed (up to a maximum of 24 months), less any penalty otherwise imposed is applied if the failure to file is made knowingly or under circumstances amounting to gross negligence. The amount of this penalty is $1,000 per month (up to 24 months) in circumstances where there is a failure to comply with a demand to file the return. In addition, a further penalty may be imposed where a failure to file a T1135 return is made knowingly or under circumstances amounting to gross negligence and continues for more than 24 months, in the amount of 5% of the total cost of specified foreign property to the reporting entity (at the highest point in the year), less the penalties assessed under the other provisions described above.
Failure to file a return may also be subject to the “general” offence provisions of the Canadian taxing legislation (which include fines/imprisonment) in egregious cases.
A partnership that is a “specified Canadian entity” will also generally be required to file an annual information return (similar to T1135) in respect of a non-resident corporation that is a “foreign affiliate” of the partnership. Generally speaking, a foreign affiliate of a particular taxpayer is a corporation not resident in Canada (i) in which the particular taxpayer has a direct or indirect equity interest of at least 1%; and (ii) in which the particular taxpayer together with all related persons has a direct or indirect equity interest of at least 10%.
A similar requirement to file an annual information return would also apply in respect of a partnership which is a “specified Canadian entity” to the extent that it has received a distribution of property from, or is indebted to, certain types of non-resident trusts. This requirement does not apply, in respect of a non-resident trust an interest in which is “specified foreign property” for purposes of the reporting obligations discussed above, so as not to duplicate the reporting requirements.