INBOUND FINANCING AND INVESTMENTS 2010 MINING TAXATION UPDATE ACUMEN INFORMATION MAY 10, 2012 Steve Suarez Borden Ladner Gervais (Toronto)

INBOUND FINANCING AND INVESTMENTS

2010 MINING TAXATION UPDATE

ACUMEN INFORMATION

MAY 10, 2012

Steve SuarezBorden Ladner Gervais (Toronto)

2

OVERVIEW OF PRESENTATION

1. Financing & Inbound Investment• Debt Financing• Equity Financing• Alternative Investments• Non-Resident Acquisitions of Canadian Mining Companies

2. Exit Strategies• Taxable Canadian property• Tax treaty protection• s.116 issues

3. Cross-Border Canada – U.S. Issues• Limitation on benefits under the Canada-U.S. Treaty• Using hybrid entities in inbound transactions

3

Financing & Inbound Investment

Non-residents making Canadian mining investments (new projects in Canada, acquiring interests in existing projects or acquiring interests in existing Canadian entities) must consider:

• Canadian income tax• Canadian withholding tax• home-county taxes• limited legal liability• day-to-day functionality

In most cases other than straightforward lending or royalties, this will involve using a Canadian corporation (directly or indirectly) as the investment vehicle

4

Financing & Inbound Investment

Debt Financing: non-residents have a number of important considerations to balance

• where to locate interest expense

• thin capitalization limitations on Canadian interest deductibility

• possibilities for double-dip financing

• Canadian interest withholding tax

• Other considerations

5

Financing & Inbound Investment: Debt

On simple loans to arm’s length borrowers, a non-resident will typically be worried only about home country taxation of interest income• no Canadian withholding tax on interest paid to a non-resident creditor dealing at arm’s length with Canadian borrower, unless interest is “participating” (e.g., variable based on profit, cash flow, etc.)

Otherwise, if non-resident is debt-financing a Canadian investment, need to consider whether• interest expense deductions are most useful in Canada or the non-resident’s home country (effective tax rate, where sufficient taxable income exists, etc.); • withholding tax costs of lending to Canada; and• is there any scope for multiple deductions?

6


Thin capitalization restrictions (s.18(4)ITA)

Canadian corporations are restricted on the amount of interest expense they can deduct on debt owing to “specified non-residents”: non-residents who own, or deal non-arm’s length with someone who owns, 25%+ of Canco’s equity (by votes or value)

No interest deduction on debt owing by Canco to specified non-residents, to the extent it exceeds 2x Canco’s “equity”, being the sum of• Canco’s start-of year unconsolidated retained earnings;• Canco’s contributed surplus received from specified non-resident shareholders; and• paid-up capital of Canco shares owned by specified non-resident shareholders

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Thin capitalization restrictions are being tightened under the March 2012 federal budget

• debt/equity limit being reduced to 1.5:1 (effective 2013)• rules now capture debt of partnerships that have Canadian corporations as partners• disallowed interest expense with be treated as a dividend (not

interest) for withholding tax purposes

See “Canadian 2012 Federal Budget: Tightening the Screws,” included with materials

8


Foreign Parent

$50M equityForeign

Finance Co

Canco

$100Mloan

Starting in 2013, Canco can only deduct interest on $75M of the debtowing to Foreign Finance Co• no deduction for interest on the remaining $25M, which is treated

as a dividend and subject to dividend withholding tax

9


Double-Dip Structures

Where U.S. parent is lending to Canadian subsidiary, consider whether a “double dip” hybrid structure can be used to create an instrument that is debt for Canadian purposes (deductible interest expense for Canco) but equity for U.S. purposes (no interest income for U.S. parent)

10


Summary1. US Co uses proceeds of 3rd party debt to make a loan to Canco

2. Simultaneously, LLC enters into a forward subscription agreement with Canco to purchase Canco shares for cash equal to the principal amount of the loan on the maturity date

3. Simultaneously, US Co enters into a support agreement with LLC to purchase shares for cash in order that LLC can fund its obligation under the forward subscription agreement

4. Simultaneously US Co provides Canco with a guarantee of LLC’s performance under the FSA

1. Loan

US Co

CancoLLC

Third-party debt

2. Forward Subscription Agreement

4. Guarantee

3. Support Agreement

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Summary1. Loan from US Co to Canco

2. Forward subscription agreement between LLC and Canco

3. Support agreement between US Co and LLC

4. Guarantee from US Co to Canco


US Co

Canco

LLC4. Guarantee 1. Loan

3. Support Agreement

2. Forward Subscription Agreement

12


Interest Withholding Tax

Under Part XIII, Canada no longer levies withholding tax on interest (other than participating interest) paid to a creditor dealing at arm’s length with the debtor

“participating debt interest” means interest (other than interest described in any of paragraphs (b) to (d) of the definition “fully exempt interest”) that is paid or payable on an obligation, other than a prescribed obligation, all or any portion of which interest is contingent or dependent on the use of or production from property in Canada or is computed by reference to revenue, profit, cash flow, commodity price or any other similar criterion or by reference to dividends paid or payable to shareholders of any class of shares of the capital stock of a corporation.

13


Interest Withholding Tax: other relevant provisions

s.214(6): deemed payment of accrued interest on transfer of bond, etc. by a non-resident to a Canadian resident, if bond issued by Canadian resident

s.214(7): deemed payment of interest on transfer of bond, etc. by a non-resident to a Canadian resident, if issued by Canadian resident and transfer price exceeds issue price of the bond

s.214(8): “excluded obligations”, carved out of s.214(7) and partially carved out of s. 214(6) (former 5/25 debt or shallow discount debt issued for not less than 97% of principal amount)

14


Interest Withholding Tax: convertible debentures

There is considerable uncertainty as to the tax treatment of holders of convertible debentures who are non-residents• not clear whether the value of shares received on conversion

over principal amount is “participating interest” (if so Canadian withholding tax applies on sale or conversion of debenture)• not clear whether “regular” interest is tainted by the conversion premium

CRA administrative position has been “under development” for almost 4 years, and remains in progress

15


Interest Withholding Tax: Tax treaty structuring

While most of Canada’s tax treaties reduce the 25% rate of Part XIII interest withholding tax to 10%, the rate under the Canada-U.S. Treaty for U.S. residents entitled to Treaty benefits is 0%, even if dealing non-arm’s length with the debtor

➙ This creates an incentive for non-residents outside the U.S. to consider financing into Canada through a U.S. group member, in order to get 0% interest withholding

Issues to watch for• limitation on benefits under the Canada-U.S. Treaty• anti-hybrid rules in Canada-U.S. Treaty• anti-avoidance mechanisms (discussed below)

16


Interest Withholding Tax: Financing Through the U.S.

ForeignParent

Canco

Debt(10% w/h tax)

ForeignParent

Canco

U.S. Financeco

Debt(0% w/h tax rate)

17


s.78: Accrued and Unpaid Interest:

Deductible amounts owing to a non-arm’s length person and which remain unpaid at the end of the second taxation year following the year it was incurred, are added back to income in the third following year, unless the parties jointly elect to deem the amount to have been paid

Figure 1. Accrued Non-Arm’s-Length Interest and Section 78(1)

Interest accrues for 2009

12/31/08 12/31/09 12/31/10 12/31/13 12/31/12

Payment deadline for 2009 interest

Deemed-payment election deadline

12/31/11

18


Foreign Exchange Issues

When lending into Canada, consider the F/X implications of the loan

• Canadian debtor borrowing non-Cdn. $ will realize income/gain/loss on maturity, with any loss probably denied recognition if incurred on debt from a non-arm’s length lender

• Canadian debtor should not assume any gain will be a capital gain: need to consider capital/income treatment

• Canco may want to consider making the s.261 foreign currency election in appropriate circumstances

For more on the tax treatment of F/X gains and losses, see “Canadian Taxation of Foreign Exchange Gains and Losses” at www.miningtaxcanada/about/

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Financing & Inbound Investment: Equity

Equity Financing: principal Canadian tax considerations for non-residents making an equity investment in Canada:

• tax recognition of cost of investment

• maximizing cross-border paid-up capital (PUC)

• minimizing Canadian dividend withholding tax

• minimizing Canadian taxation of gains on exit

• managing s.116 obligations on sale

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Paid-up Capital

• Tax equivalent of corporate law share capital

• Basic concept is that shareholders should be able to extract PUC without being treated as receiving a dividend (but reduces shareholder’s cost in the share)

• Each share of the same class or series has the same PUC (PUC of class divided by # of shares)

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Y

$200

FMV = $200Cost = $100PUC = $150

CanCo

Cost/FMV = $200PUC = $150

X

$200

FMV = $200Cost/PUC = $100

CanCo

Before

X Y

After

Paid-up Capital: pooled within each class

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Paid-up Capital: non-residents

Especially important for non-resident purchasers

• PUC can be extracted out of Canada without dividend withholding tax

• PUC increases how much debt Canco can incur from related non-residents on an interest-deductible basis

• 2012 federal budget targets PUC increases where foreign-controlled Canco makes an “investment” in a foreign affiliate that does not satisfy a business purpose test (see “Canadian 2012 Federal Budget: Tightening the Screws”)

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Paid-up Capital: non-resident acquisition

$10M

FMV = $10MPUC = $2M

Canco

Non-ResidentBuyer

Vendor

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Canco

Incorrect

Non-ResidentBuyer

FMV/Cost = $10MPUC = $2M

Vendor

$10M

New Canco

Correct

Non-ResidentBuyer

FMV/Cost/PUC = $10M

Vendor

$10M

FMV/Cost = $10MPUC = $2M

Canco

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Equity Distributions

A Canadian corporation can choose to make a distribution to shareholders either as (1) a dividend, or (2) a return of capital (to the extent of the stated capital of its shares)

• unlike the U.S., there is no rule treating all distributions as dividends for tax purposes to the extent the corporation has earnings & profits (E & P)

A dividend triggers dividend withholding tax but does not reduce the holder’s basis in the share

A return of capital reduces basis in the share and is not treated as a dividend to the extent of PUC (except where s.84(4.1) applies)

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Equity Distributions

In a mining investment, the prospect of dividends is often remote unless the Canadian corporation is a producer of significant size (mining is very capital-intensive)

• dividend-paying mining corporations tend to be large public companies, which are severely limited in their ability to make capital reductions for tax purposes due to s.84(4.1)

As a result, choice of jurisdiction to hold Canadian mining shares is usually driven by (1) recipient-country taxation, and (2) managing Canadian taxation of gains on dispositions, (see Exit Strategies)

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Dividendfrom Canco

PUC Reduction from Canco

Loan from Canco

Withholding Tax

25%; potentially reduced as low as 5% by tax treaty (note Canada-U.S. problem with ULCs)

None if sufficient PUC; reduces holder’s basis in shares of payer

None if repaid within permitted timeframe and not part of a series of loans and repayments; otherwise treated as a dividend

Comments Consider whether relevant Canadian corporate law places any constraints on Canco’s ability to declare and pay dividend (e.g., solvency test)

No U.S. style E&P rule; can choose to reduce PUC even if profits exist (subject to s.84(4.1) for public corporations)Consider effect on thin capitalization rules to Canco

Various rules require market interest rate to be charged by Canadian lender

Financing & Inbound Investment: Periodic Repatriations

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Financing & Inbound Investment: Royalties

It is relatively unusual for foreigners to invest in a Canadian mining project in the form of a royalty, as these tend to be tax-inefficient

• effectively no cost recognition for Canadian purposes, as CDE pool rarely of use to a non-resident

• royalties subject to 25% withholding tax under Part XIII

• Canada’s tax treaties tend to offer little or no relief from Canadian taxation of Canadian-source mining royalties

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Financing & Inbound Investment: Metal Streams

Metal stream transactions are a particular form of mining transaction that typically sees a producer sell secondary output (e.g., silver from a gold mine) to an arm’s length purchaser, usually on the basis of an upfront payment plus a relatively low price per unit delivered (considerably less than spot)

• structured so as not to be a royalty

• up-front payment often set up as a deposit

While possible to effect directly into Canada, (especially where the mine is located in Canada) metal stream transactions are typically set up with a foreign subsidiary of the Canadian mining company

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Financing & Inbound Investment: Metal Streams

Income Tax Results:• Vendor: payments from

Vendor Subco included in income when received

• Vendor Subco: upfront payment included into income when received; s. 12(1)(m) reserve claimed for goods to be delivered in future. Sales income from Purchaser included into income as received.

Vendor

VendorSubco

MineSpotContract

Purchaser

ForwardContract

Vendor sells output to vendor Subco at spotVendor Subco sells output to Purchaser at lesser of spot and Kn price, with an upfront payment

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Financing & Inbound Investment: Acquisitions

Acquisitions of Canadian mining companies: see B. Sinclair’s presentation

• form of transaction• form and amount of consideration• process• structuring considerations

purchaser (s.116 issues, s.88(1)(d) bump, exit strategy)

vendor (tax minimization, deferral, s.116 issues)• pre-and-post transaction planning

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Points of particular relevance to non-resident purchasers

• maximizing cross-border PUC (to maximize Canadian interest deductibility under thin capitalization rules and the ability to effect distributions as PUC returns)

• s.88(1)(d) bump• limited to using cash consideration• especially useful to extract Target’s foreign subsidiaries out of Canada

• limited ability to offer tax deferral to Target shareholders who are taxable in Canada on gains (unless using exchangeable shares)

• special considerations when planning for sale of investment (minimizing Canadian tax on gains)

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Illustration of Inbound Acquisition Planning

Pre-Acquisition

Bidco

Foreign Parent

EquityFMV/PUC/Cost = $120

$180debt

$300

Canada

Shareholders

FMV = $300PUC = $80

Canco

FMV = $210Cost = $85

FMV = $90CCDE/CCEE = $45

ForeignSubsidiary

CanadianMine

ForeignMine

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Post-Acquisition

Foreign lender/shareholderlocated in appropriate taxTreaty country regardingInterest/dividends/gains

Foreign Parent

Foreign Holdco

Bidco(post-amalgamation)

EquityFMV/PUC/Cost = $120

$180Debt

Canada

Bidco/Canco mergerconsolidates interestexpense with operatinginterest income

FMV = $210Cost = $210

ForeignSubsidiary

ForeignMine

ForeignMine

FMV = $90CCDE/CCEE = $45Cost of bump-

Eligible propertyincreased

Planning to use targetlosses and managesuccessor rules

Use of foreign holdcoprovides flexibility onsale

Bidco debt/equityoptimized regardingthin cap

Consider pre-acquisitionPlanning for bump-eligibleproperty

Shareholders

$300

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For more on acquisitions of Canadian mining corporations see:

• www.miningtaxcanada.com/mergers-acquisitions/

• “Using Exchangeable Shares in Inbound Canadian Transactions” (About page of website)

• “Canada’s Tax Cost Step-Up: What Foreign Purchasers Should Know” (About page of website)

• “Canada’s Section 116 System for Non-Resident Vendors of Taxable Canadian Property” (included with materials)

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Exit Strategies

The time to plan for how to exit an investment in Canadian mining is before making the investment, especially for non-residents. Careful planning can help minimize:

• Canadian capital gains tax

• Canadian s.116 obligations

• home-country taxation (direct and CFC)

Taxpayers are invariably more successful with planning that is put in place at the time the investment is made as opposed to planning done near the time of sale

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Exit Strategies: Debt

Unless somehow convertible into or exchangeable for another property, a debt investment into Canada will generally not constitute “taxable Canadian property” so as to be subject to Canadian capital gains tax or s.116 obligations

• simply lending to a Canadian mining company does not create TCP

But consider the potential for s.214(7) to create Part XIII tax on sale or redemption if proceeds exceed issue price and debt is not an “excluded obligation”

38

Exit Strategies: Equity

When making an equity investment in Canada, the three principal Canadian tax considerations are:

• will the investment constitute TCP, so as to be subject to Canadian capital gains tax

• if so, can protection from Canadian capital gains tax be found in a relevant tax treaty

• if the investment constitutes TCP, do the parties have obligations under the s.116 system governing dispositions of TCP by non-resident vendors

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Taxable Canadian Property• includes interest in Canadian real property or Canadian resource

property (which includes most mining royalties)• property used or held in a business carried on in Canada• share not listed on a designated stock exchange (other than of a

mutual fund corporation) or partnership interest or trust interest (other than of a mutual fund trust), that derives its value (directly or indirectly) primarily from Canadian real/resource properties anytime in the preceding 60 months (other than through a corporation, partnership or trust whose shares/interests are not TCP)

• share that is listed on a designated stock exchange, or of a mutual fund corporation, or interest in a mutual fund trust, if at any time in the preceding 60 months both:

• more than 50% of the share’s/interest’s FMV was derived (directly or indirectly/ from Canadian real/resource properties; and

• taxpayer (together with non-arm’s length persons) owned 25%+ of corporation’s shares or MFT’s units

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Property TCP Status

Shares of corporations listed on a designated stock exchange; shares of mutual fund corporations; units of mutual fund trusts

TCP if at any time during the preceding 60 months, both1. the nonresident holder owned more than 25 percent of any class of the corporation’s shares or the trust’s units (including any shares or units owned by non-arm’s length persons), and2. more than 50 percent of value of the shares or units was derived (directly or indirectly) from Canadian real property

Unlisted shares of corporations (other than mutual fund corporations); interests in partnerships and most trusts

TCP if at any time during the preceding 60 months more than 50 percent of value of the share or interest was derived from Canadian real property directly or indirectly (otherwise than through a corporation, partnership or trust the shares or interests of which are not themselves TCP at that time)


Summary: TCP Status

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Determination of taxable Canadian property status for shares

2010 Budget narrowed TCP status for shares: only TCP if shares derive value primarily from Canadian real property in past 5 years (directly or indirectly)

Previously, CRA had allowed taxpayers to make “value primarily derived” determination based on (1) corporation’s gross assets, or (2) corporation’s net assets, allocating liabilities on a reasonable basis

42


At 2011 CTF Round Table, CRA announced a change in its administrative policy

1. For property held by the taxpayer any time during 2011 and disposed of before 2013, old policy applies

2. For all other property, the CRA will make “value primarily derived” determination based on gross assets

Q: shouldn’t the value of a share be based on the value of the corporation’s assets less all claims ranking ahead of the shares, i.e., on a net assets basis?

43


Tax Treaties: where the Canadian equity investment will (or may in the future) constitute TCP, it is essential to consider whether tax on sale could be reduced either by

• structuring the exit as a dividend for Canadian tax purposes (if dividend withholding tax is less than Canadian capital gains tax), or

• using a tax treaty to achieve a more favourable result, taking into account (1) Canadian taxation of the gain, (2) taxation of the gain in the shareholder’s jurisdiction, (3) costs of

distributing the sale proceeds out of the shareholder’s jurisdiction (whenever this occurs) and (4) taxation of that distribution in the jurisdiction of the ultimate parent

44


Tax Treaties: there is a very wide range of protection from Canadian capital gains taxation on a sale of shares in Canada’s tax treaties (see “Canadian Taxation of Mining,” included with materials) – for example:

No relief (e.g., Chile. ,Argentina, Brazil, Australia, Japan, India)

Taxation if share value derived primarily from Canadian real property (e.g., China, Singapore, Korea, Ireland)

As above, but operating mines excluded from “real property” (e.g., Netherlands, Germany, South Africa, Luxembourg, Switzerland, U.K.)

Taxation limited to Canadian corporations (Netherlands, Russia, Switzerland, U.S., Germany)

Publicly-listed shares excluded (Luxembourg, Netherlands, U.K., Germany, Switzerland)

Minimum ownership threshold, usually 10% (South Africa, U.K., Netherlands, Luxembourg, Switzerland)

45


Tax Treaties

Residence:mind and management is not in jurisdiction of entity’s governing law

Agency: entity is acting as agent for someone else

Beneficial Ownership: entity is not the beneficial owner of the relevant property

Sham: purported legal relationships do not in fact exist

Treaty Shopping: use of treaty jurisdiction somehow inherently abusive

46


s.116 System: applicable to dispositions of TCP by a non-resident (whether or not any tax is owing or any gain exists), unless an exception applies; consists of

• vendor notification obligation

• purchaser remittance obligation

• vendor tax return filing obligation

See “Canada’s Section 116 System for Non-Resident Vendors of Taxable Canadian Property” (included with materials)

47


s.116 System: Excluded Property

Generally no s. 116 system obligations arise to the extent the TCP is “excluded property,” which includes:

• shares listed on a recognized stock exchange

• deemed TCP (e.g., shares received on a tax-deferred rollover)

• bonds, debentures, mortgages and similar obligations

• options/interests in respect of the foregoing

• “treaty-exempt property” (which requires the purchaser to notify the CRA within 30 days of sale if the purchaser and vendor are related)

48


s.116 System: Vendor notification obligation

Vendor is required to notify the CRA within 10 days of the disposition, unless the TCP is (1) excluded property, or (2) property described in s.116(5.2), viz., property that may yield income on disposition

s.116 System: Vendor Tax Return Obligation

Vendor is required to file a Canadian tax return, unless all TCP dispositions in the year are (1) of excluded property, or (2) ones in respect of which the CRA issued a certificate of compliance

49


s.116 System: Purchaser remittance obligation

Purchaser is liable to remit to the CRA (and may withhold from the purchase price) 25% of the purchase price, unless

• property is excluded property;

• purchaser reasonably believes that vendor is not a non-resident, after making reasonable inquiry;

• requirements for s.116(5.01) “treaty protected property” exception are met; or

• CRA has issued a certificate of compliance

50


s.116 Withholding: Treaty-protected property exception

Where a non-resident vendor is claiming to be exempt from tax on a disposition of TCP due to a treaty exemption, purchaser can1. withhold and remit;2. demand a certificate of compliance; or3. file Form T2062C within 30 days of sale under s. 116(5.01)

Problem with 3. was that s.116(5.01), which was introduced in 2008, does not exempt the purchaser from liability if treaty exemption does not in fact apply (e.g., due to valuation uncertainty, chattel/fixture uncertainty, former residence, limitation on benefits, anti-avoidance, etc.)

➙ Result: Purchasers often unwilling to rely on 3.

51


s.116 Withholding: Treaty-protected property exception

Statement on CRA website (“Disposing of or acquiring certain Canadian property”) now provides that CRA will generally not assess a purchaser for not withholding in good-faith belief that non-resident was treaty-exempt if• purchaser has filed Form T2062C;• purchaser and vendor are unrelated; and• purchaser has made every reasonable effort to determine that property is treaty-exempt“Every reasonable effort” means at least the steps suggested on Form T2062C

52

Canada-U.S. Treaty Issues: Limitation on Benefits

Canada’s treaty with the U.S. is the only Canadian tax treaty that contains a comprehensive “limitation on benefits” (LOB) Article, restricting who may claim benefits under the Treaty (it is not enough just to be a U.S. resident)

U.S. subsidiaries of foreign corporations generally do not qualify under the base test

See “Thoughts on the New LOB Clause in The Canada-U.S. Treaty” (included with materials)

53


Is person seeking treaty

benefits a U.S. resident

for treaty purposes?

Yes

Is U.S. resident a qualifying person?

No

Are benefits available under “active trade or

business exception”?

No

Treaty benefits available only if

“derivative benefits” test met (limited

benefits only) or under residual exception in Article XXIX-A(6).*

Yes YesNo

Not eligible for treaty benefits.

Eligible for treaty

benefits.*

Eligible for treaty

benefits.*

* Availability of treaty benefits subject to antiabuse rules as per Article XXIX-A (7).

Limitation on Benefits: Summary of Analysis

54


Basic test: is the U.S. resident claiming Treaty benefits a “qualifying person”?

1. natural person

2. corporation whose principal class of shares primarily traded on recognized Canadian or U.S. stock exchange

3. corporation more than 50% of whose shares (by votes and value) are owned by 5 or fewer persons described in 2 (directly or indirectly

through a chain of qualifying persons)

4. corporation 50% or more of whose shares (by votes and value) are not owned (directly or indirectly) by non-qualifying persons

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benefits a U.S.

resident for treaty

purposes?

Yes

Is the U.S. resident (or

related person) actively

conducting a trade or

business in the U.S.

(other than an ineligible business)?*

Is the U.S. trade or business substantial

relative to the activity carried on in Canada

giving rise to the income on which the U.S. resident is seeking treaty

benefits?

U.S. resident entitled to

treaty benefits with respect to connected or incidental

income, subject to antiabuse limitations.

No

Active trade or business

exception not available.





* An ineligible business is the making or managing of investments, unless carried on with customers in the ordinary course of business by a bank, insurance company, registered securities dealer, or deposit-taking financial institutions.

Is the Canadian-source income

derived in connection with or incidental to the

U.S. trade or business (directly

or indirectly through one or more Canadian

residents)?



Yes Yes Yes

NoNo

No

Active Trade or Business (ATB) Test Summary

56



benefits a U.S.

resident for treaty

purposes?

Yes

Are 90% + of U.S. company’s shares* owned,

directly or indirectly, by

qualifying persons or

eligible third-country

shareholders?**

Are U.S. company’s eligible

third-country shareholders

entitled to Canadian tax rate

on the relevant income as low or

lower than the corresponding rate under the

treaty?

U.S. company entitled to

treaty benefits under Articles X (Dividends), XI (Interest),

and XII (Royalties), subject to antiabuse limitations.

No

Not eligible for derivative benefits.



•“Debt substitute shares” are ignored under this test, and a further test applies if a “disproportionate class of shares” exists.

** An eligible third-country shareholder is a resident of a third country entitled to full benefits under a treaty between Canada and that third country, and who (if resident in the U.S.) would either be a qualifying person under the Canada–U.S. treaty or eligible for treaty benefits under the “active trade or business” test (if it was assumed that the shareholder carried on in the U.S. the same business it in fact carries on in the third country).

Does U.S. company meet base erosion

test (deductible expenses payable to

non-qualifying persons < 50%

of gross income)?


Yes Yes Yes

No

No

No

Derivative Benefits Test Summary

57

Canada-U.S. Treaty Issues: LLCs

For many years, Canada refused to extend Treaty benefits to LLCs that are disregarded for U.S. tax purposes, on the basis that they were not U.S. residents (liable to pay tax in the U.S.), and would not look through them (like partnerships) to allow the LLC members to claim Treaty benefits

CRA continued this position in spite of Tax Court decision in TD Securities LLC v. The Queen holding the taxpayer LLC to be entitled to Treaty benefits

Article IV(6) (added by the 2007 Protocol) addresses this, by allowing Treaty benefits to be claimed by U.S. residents (only) on items of income earned through a disregarded LLC

58

Canada-U.S. Treaty Issues: Anti-Hybrid Rules

Unlimited Liability Corporations (ULCs): popular with U.S. companies investing in Canada, because they can elect to disregard the ULC for U.S. tax purposes

Under Article IV(7)(b) of the Canada-U.S. Tax Treaty, Treaty benefits are denied where U.S. taxation is different as a result of the ULC being disregarded for U.S. tax purposes➙ 25% Canadian withholding tax instead of 0% (interest) or 5% (dividends)➙ especially problematic on payments from ULC to LLC

There are work-arounds, but use disregarded ULCs with caution

59


Article IV(7)(b)

An amount of income, profit or gain shall be considered not to be paid to or derived by a person who is a resident of a Contracting State where:

(a) The person is considered under the taxation law of the other Contracting State to have derived the amount through an entity that is not a resident of the first-mentioned State, but by reason of the entity not being treated as fiscally transparent under the laws of that State, the treatment of the amount under the taxation law of that State is not the same as its treatment would be if the amount had been derived directly by that person; or

(b) The person is considered under the taxation law of the other contracting State to have received the amount from an entity that is a resident of that other

State, but by reason of the entity being treated as fiscally transparent under the laws of the first-mentioned Sate, the treatment of the amount under the taxation law of that State is not the same as its treatment would be if that entity were not treated as fiscally transparent under the laws of that State.

60


LLC Owning Shares of Disregarded ULC

CRA says the better view is thatU.S. residents cannot claim Treatybenefits on amounts paid by a ULCto an LLC where both entities areand the income item disregardedfor U.S. tax purposes: see CRAdocument 2009-0345351C6, datedFebruary 11, 2010

Consider inserting a third country(i.e., Luxembourg) between LLCand ULC, so that a different treatyapplies

U.S.

Canada

U.S. Residents

LLC

ULC

61


Dividends Paid by Disregarded ULCs

U.S. Corp

U.S.

CAN

Dividends

U.S. Corp

U.S.

CAN

Base Case 2 - Step Work-Around

ULC ULC

Step 2. Return of PUC Distribution

CRA document 2009-0348581R3

Step 1. ULC PUC increase (deemed dividend for Canadian purposes)

62


Disregarded ULCs and Interest

USCo

100%

USCoULC

Interest-Bearing Loan

Base Case

25% InterestWithholding

USCo

USSub

USSubULC


63


Disregarded ULCs and Interest

USCo

USSub

USSubULC


90%

10%

Alternative 2: PartnershipCRA document 2009-0318491I7

64

The End

Thank you

For more on the Canadian taxation of mining, go to www.miningtaxcanada.com

Steve SuarezBorden, Ladner Gervais LLP (Toronto)

416 [email protected]

Documents

INBOUND FINANCING AND INVESTMENTS 2010 MINING TAXATION UPDATE ACUMEN INFORMATION MAY 10, 2012 Steve Suarez Borden Ladner Gervais (Toronto)