On August 27, 2010, the Canadian government once again released draft legislation to amend the Income Tax Act (the “Act”) relating to investments in so-called “non-resident trusts” (NRTs). The NRT rules will operate to deem certain non-resident trusts to be resident in Canada for most income tax purposes, and will cause Canadian resident beneficiaries and Canadian resident contributors of such a trust to be jointly and severally liable for all or some of the non-resident trust’s Canadian income tax. Numerous drafts of these rules, which were first announced in 1999, have been introduced over the last decade. However, none of these prior proposals was enacted. Under the last reiteration of these rules, introduced in 2007, investments by certain tax-exempts, such as Canadian pension funds, in certain non-resident trusts could have potentially resulted in a Canadian tax liability for the Canadian pension fund investor. Lobbying by the Canadian pension community against the application of the NRT rules to tax-exempts such as Canadian pension funds (including a submission on December 11, 2007 by the Pension Investment Association of Canada outlining the draconian consequences of the NRT rules in the context of pension plan investment) has been successful.
Canadian resident contributors and beneficiaries who qualify as “exempt persons” will not be subject to the NRT rules. The August 2010 proposals expand the definition of “exempt persons” to include tax-exempt entities, such as pension funds, as well as intermediary corporations, trusts and partnerships, through which many tax-exempt entities invest. In particular, the definition of “exempt person” will include:
- registered pension plan trusts;
- elected master trusts which are tax-exempt under paragraph 149(1) (o.4) of the Act;
- regular taxable Canadian resident trusts, all of the beneficiaries of which are exempt persons. Such a trust would include, for example, a pension master trust that was not itself an elected master trust under paragraph 149(1)(o.4) of the Act;
- Canadian corporations all of the shares, or rights to shares, of which are held by exempt persons; and
- partnerships, all of the members of which are exempt persons.
Accordingly, pension funds and most intermediaries through which they make investments will now be exempt from the NRT rules. The scope of the proposed amendments is welcome, and even broader than anticipated. Prior comments on the issue in an April 2, 2008 Department of Finance comfort letter and again in the 2010 Federal Budget appeared not to extend relief to intermediary vehicles which did not themselves qualify for tax-exempt status.
Concurrently with the reintroduction of the NRT rules, the Canadian government announced amendments to the “foreign accrual property income” (FAPI) regime. The modified FAPI rules replace prior proposals aimed at investments in so-called “foreign investment entities” (FIEs). The proposed modified FAPI regime incorporates the definition of exempt persons from the NRT rules and will exempt such persons from the modified FAPI rule for investments in certain non-resident commercial trusts.