International Taxation

International Taxation

Me. Paul Setlawke (Winter 1999)

by Trent Mell1Notional Individual

ITA Answers21. Part XIII - Withholding Tax22. Part I - Income Tax2Residence2R. v. Gurds2Special Rules on Residence3Residents4Chapter 2: Employee & Individual Tax Problems5Hale5Hewitt5Ch. 3: Non-Residents with Canadian Business Operation6Sunbeam Corporation7Panther Oil7Canadian Enterprise - p. 307GST7Other tests (p. 31)7Services - test of performance7Note (Drew): under a tax treaty need7Permanent Establishment Cases71. Dudney v. The Queen [1988] T.C.C.72. Cudd Pressure Control [1998] F.C.A.7Partnership7Use of agents (32)7Distributorship8Pullman:8Carrying on a Business Cases81. Gurds [1985] F.C.A.82. Capital Life Insurance [1986] F.C.A.83. Sudden Valley [1976] F.C.A.8IV. Consequences of NR Carrying on a Business in Canada8V. NR Utilizing a Canadian Subsidiary (p. 39)8ch. 4 - Real Property10Trust11Ch. 5 Non-Resident Withholding Tax13Nestle Enterprises Ltd v. MNR [1991]13Types of payments13s. 212 (a) Management fees13s. 212(1)(b) - Interest14s. 212(1)(c) - Estate of Trust Income14s. 212(1)(d) - Rent, Royalties, etc.14212(2) - Dividends14s. 212.1 - Anti-avoidance rule against surplus stripping15NROs - Non-resident owned investment corporations15Ch. 6 - Withholding Tax on Interest17Chapter VII: Canadians doing business abroad - Foreign Tax Credit19126(1) - Non-business income tax19126(2) - Business income tax19FTC193 Possible Systems19126(7) - non-business income tax defn19126(7) - business income tax19126(1) - FT deduction1995(1) - Foreign affiliate defn19Section 17 - Loan to NR20Setlawke Structure:20Above structure will be look at to study 3 different issues:21Norway loan21Transfer Pricing - example 121Transfer Pricing - example 221Conclusion:21Paper Remarks21Ch. 8 - F.A.P.I. (ss. 90-95)22Purpose22Levels of FAPI taxation:221. Non Foreign Affiliate222. Foreign Affiliate223. Controlled Foreign Affiliate2391(1) Amounts included from FA231. 95(1) defn of FA232. 95(1) defn of CFA23Ludmer Case (76)233. 95(1) defn of FAPI2395(1) Defn of active business of a FA2495(1) Defn of income from an active business24Inter-affiliate payments24Note on IBC25ANALYSIS25Definitions - 5907(1)2694.127ch. 10 - Foreign Affiliate Share Exchange & Mergers28Domestic Transactions28FA Transactions28s. 85.1(3)2895(2)(c)2995(2)(d) - Foreign merger30Ch. 11 - Offshore Trusts3194(1) - re offshore trusts31XII. Avoidance & Evasion33Golden case, SCC33New developments since book put together: 3 new cases.33Evasion v. Avoidance33Redpath (141)33Myers (141)33Stubart33Newman34Shell (Kiwi)34Tax Planning v. Tax Avoidance (144)34GARR - s. 245341) McNicholl, Tax Ct352) Equilease35Held:353) Nadeau35

Note to Reader:

What follows are unedited class notes. Beware of possible errors Ive been known to make a few!

Other Sources:

Stikeman Bulletins

Matthew Bender

Canadian Tax Foundation Annual Reports

Tax Journals

Michael Edwards Carr on interp of tax treaties

Whats international tax

Capital / profit / people moving between countries

Domestic law on the interaction between countries

Claims enforced domestically

Citizenship / Domicile / Residence

C:

D: Where you intend to be

R: Where you are

How should a country tax?

Canada & most countries - by Residence

US - by Citizenship

born in Canada to a parent who is a US citizen: taxable in Canada & US

Result: double taxation or pay in one or the other

Domicile

Not relevant in Cda

Is relevant in the US for gift tax & estate tax purposes

Corporations

Determine R; deemed R provisions, CL test

Taxable entities (Cda: 1-3)

1. Individuals

2. Corporations

3. Trusts

4. Partnerships

5. Foundations

6. Stiching

7. Stiftugn

Notional Individual

A. Domestic sources of Income

1. Interest

2. CG

3. Business Income

Gifts - Not taxed in Cda but in most countries

Wealth taxed in France

B. Foreign sources of income

Should there be tax on income earned outside Cda

C. Corp in BVI

Should there be tax on income earned from a foreign income

Have to, otherwise tax avoidance encouraged

Tax the indiv or the corp? If tax per control, what if its split btw 3 countries?

Point: Each country has own mindset - each distinct

ITA Answers

1. Part XIII - Withholding Tax

s. 212 - 25% tax on non-residents for passive income paid by Canadian resident

interest, dividends, royalties, rent, trust distributions

Is Bombardiers interest payment on money borrowed in Europe subject to tax?

No, cant be what s. 212 means.

Many exceptions to the provision

Interest in particular (212(1)(b)(7) - Bombardier)

Tax treaties

2. Part I - Income Tax

s. 2 - how R & NR are taxed & on what

Simple to read but key to whole ITA

2(1) - IT paid on all taxable income earned by a resident Cdn basis: world income of residence

Similar in US, UK but not Hong Kong

2(3) - NR will pay taxes where

(a) Employed in Cda

(b) Carried on business in Cda

(c) Disposed of a taxable Cdn property (TCP)

Steps on treatment of income:

1. R or NR

2. 2(1) or 2(3)

3. s. 212 withholding tax

4. Does a Tax Treaty change the ITA provision (relief)

Residence

250(1) - Deemed Resident for the whole tax year where:

(a) sojourned in Cda for 183 days or more

(b) Cdn Forces

(c) Ambassador, minister, officer and resident immediately prior to appointment

(d) Performed services in another country under a prescribed program of the govt. of Cda (CIDA projects listed under ITA Regulations)

(d.1) Cdn forces school staff

(e) R in Cda in a previous year and a spouse of a person under (b), (c), (d), (d.1)

Proposed amendment, 1998: Where a family ceases to be factually R in Cda (factually, common law rules; outside s. 251), the spouse of a person under (b), (c), (d), (d.1) will only be treated as a R if not taxed in new country because of a tax treaty. Point: if already taxed, Cda will not also tax.

(f) Child..

250(4) Deemed R for corps where

(a) Incorporated in Cda after April 26, 1965

Keep in mind CL rules (Central mind & mgmt)

(b)

(c) Incorporated in Cda before April 27, 1965, if they carried on business in Cda they will be deemed R

See R. v. GurdsPer notes to s. 250(4), CL test must be considered in addition to this subsection

R. v. Gurds

U.S. Co. selling Crush in Iran until the Shaw is overthrown

Want to use a Cdn co. to sell without paying Cdn taxes

Want a Cdn co. formed in Cda before April 27, 1965 to sell Crush in Iran

To escape CL test: Have a majority U.S. Directors & meetings in the U.S.

Steps to avoid deeming provisions:

Make sure that since 65, Gurds was an inactive company

Make sure the co. is not carrying on business in Cda in the process

Look at:

1. What does it mean to Carry on business in Canada?

Cdn mailing address relevant? Literal (technical) or purposive (spirit) approach?

2. How a company used tax law to structure this deal

3. Judicial attitude to this type of planning

Foreign Accrual Property Income (FAPI) Rules

Rules for the taxation of income earned by foreign corporations

Purpose: Prevents Cdn R from setting up a controlled foreign affiliate (CFA) to earn interest income.

Residence - Continuation

Continuation: provisions to allow a corp to continue in another jurisdiction

International or interprov continuation: law changed & now deemed to have been incorporate on the date of continuation

Special Rules on Residence

1. 250(6) - Intl Shipping Company

BVI company are not deemed residents

Goal: attract Hong Kong residents to Cda by exempting intl shipping revenues from taxation (but taxed on other income, was thus ineffective)

2. Cdn Co owns US co with 5 Cdn Directors

Both countries will deem the subsidiary to be resident

US: tie-braker rules

See notes

3. Trusts

Generally resident where the trustees reside

Bermuda trust with Bermuda trustees are NR

FAPI rules extend to trusts however, thus NR doesnt mean not taxed

4. s. 114 - when become a resident part way through the year

Point: Rules to determine who is R and NR. Other rules to determine who is taxable & who is not.

Friday, January 15

Sources

1. ITA

2. Income Conventions Interpretations Acts

3. Treaties (modeled on OECD or UN conventions)

UN more fore treaties between developing & developed countries

4. Jurisprudence

5. Vienna law

Each treaty overrides the ITA, providing the opportunity for overlap. Does an extended definition of interest under the ITA apply to the treaty as well? What if the ITA is amended after the treaty is passed.

Residents

Non-ResidentsTaxed on world income:Part I (Income Tax):

c.g.

1 - employees

interest business income2 - carrying on business

foreign income3 - taxable Canadian property

direct

through FA & CFAPart XIII:

- Withholding Tax

Part XIV:

- Branch Tax

Residents

IndividualCorporationTrust

1. Common law rule

- Persons presence- Control & Management- Residence of trustee (Thibodeau)

2. Deemed Residence

- 183 days- Formed in Canada - na

- Govt. employee

- 94(1)(c): taxation of NR trusts

3. Deemed Not Resident

- Dual residence- International Ship Co.

- U.S. Tie Brake

Scenario A: Trust with trustee of Isle of Man Co., which has 4 Directors from 4 different countries. May meet by phone. Where is the trust resident?

Scenario B: Canadian wants to move to the U.S. Becoming a NR to Canada = departure tax. If 7 months in U.S. but has not severed ties in Canada, remain a resident in Canada

See Canada-US tax treaty (p. 2604), Art IV; Tie-breaker rules at par. 2: where is the TPs centre of vital interests

Thus deemed resident in US for purposes of the treaty but still R of Canada under the ITA (ie: departure tax still doesnt apply)

If TP wants to sell shares, what are the tax consequences? Art. XIII:4 (p. 2636): Starting point: dual resident, deemed US resident for purposes of the treaty. XIII:4 says he will be taxed only in the US.

Based on this simple reasoning, could have a huge Canadian gain, move to the US & thus not pay tax. The thinking was that there would be tax upon sale, not upon departure (preserve the right to tax for 5 years - the US can tax instead). Rev. Canada. proposed an amendment at s. 250 (see text - grey box) that deems TP to be NR for purposes of the ITA. Therefore, departure tax arises.

(Critical of Bronfman issue, which was legitimate & departure taxes generally, which arent seen outside Canada & Australia. B. used s. 107)

Chapter 2: Employee & Individual Tax Problems

NR employed in Canada

2(3)(a) - tax on NR

248(1) - taxable income earned in Canada as determined under Div. D

Division D: Taxable Income Earned in Canada by NR

115(1)(a)(i)

3(a) - basic rules on tax on income from employment

Inclusions: ss. 6-

7(1) - stock options, when exercised will generally be included in income

Hale

Hale, UK citizen, resident in Canada for 1984-85

Stock options

eg: 1000 @ $40:

leaves Canada in 1986, exercises options in 1987 (worth 60) = gain of $20,000

No departure tax on stock options

Assume a delayed bonus of $10,000 as well

Q: What does Canada tax him on?

$10,000 is taxable well skip the provision as to why

Stock option plan: 7(1)(a) - value less cost of the shares is deemed to have been received when shares are acquired. But in our case, the value accrued after leaving Canada.

Court

TP claim it is not taxable since falls under the UK Convention exemption

7(1)(b)(4) & 115(1)(a) cant apply - inconsistent with 3(2) & 15(1) of the Convention

15(1) UK Conv: pay taxes in Canada only if employment exercised there

Rev, Can. is arguing 7(4) ITA deems TP a R (& 2(3) ITA)

TP is arguing that he wasnt employed in Canada in the previous year & that the Conv trumps the ITA, thus 2(3) ITA na

Prof. not entirely clear of courts argument

Class notes, p. 16

Hurd & Hale - same fact pattern. Ct ruled both subject to Canadian tax.

Basis of taxation of employment income is date of receipt

New facts: NR deriving income outside Canada = no tax. Gets options & exercised before returning to Canada = also no tax.

If exercised after his return to Canada, will be taxable on the full accrued amount (empl income taxed upon receipt).

Hewitt

Employed in Libya & made contributions to a company plan. Upon leaving in 84, informed co. to pay to a location he would indicate later.

Upon return to Canada, tell co. to deposit to his Canadian bank account

Paid while in Canada; gut is to say: taxable in Canada

Court

Earned outside Canada, thus no tax

Equitable decision in favour of TP but effect is to reverse Hale. This ruling is out of left field.

A subsequent case held that Hewitt ratio was an aberration.

See also p. 18 - Deemed Disposition & Acquisition upon becoming resident

pp. following are special rules, less impt

p. 22 - Fed foreign tax credit per s. 126

23: s.114

Friday, January 22

Me. Guy Mason:

Ch. 3: Non-Residents with Canadian Business Operation

3 ways to do business in Canada:

1. Through a distributor

May escape tax but less control over operations

112(?) - Possibility of withholding tax

2. Through a branch

2(3)(b) - Subject to a branch tax, in the absence of a tax treaty

3. Through incorporation of a resident Canadian company

2(1) - Tax on world income

LLC - Limited Liability Company in the U.S.

Hybrid entity that the US treats as a partnership (flow-through)

Only 1 LLC in Canada: N.S.s Unlimited Liability Company

Carrying on / business / in Canada - under the ITA

s. 248(1) - Business: Inclusive definition, covering adventures

s. 255 - Canada: 12 miles from shore; covers exploration on continental shelf

s. 253 - extended definition of carrying on business:

253(c)(iii) is to include a single adventures under carrying on (reverses Tara Exploration)

253(b) - solicits orders in Canada

Isolated Tranactions

Birmount Holdings held that if an isolated transaction is consistent with a companys only business, the Tara ratio will not apply & it will constitute carrying on a business

Canadian Marconi81(1)(c) - Exemption for International Traffic (p. 26-27)

Income from the operation of a non-resident ship or aircraft will be exempt if that country grants similar relief to Canadians

Thus, if Bermuda = no tax

Furness, Withy: In this case, the company was a shipping agent for an English company but held to be taxable since the agent was not working on one of their own ships. Servicing on own ships is tax exempt, but not work done for Canadian corporations.

Extended meaning of carrying on a business in Canada

s. 253

Sudden Valley: Washington land company placed ads in Canada. Held by Rev. Canada to be taxable but court viewed as merely an invitation to treat. Offer only made once Canadians went to Washington. On a more practical level: the land & transaction was in the U.S. - no justification to impose Canadian taxes.

Case is relevant for current issue of Internet invitations to treat, where browsers are invited to buy real estate in another country (as opposed to on-line transactions for merchandise).

Distinction between Capital & Income (p. 28)

253(c)

Masri: several isolated transactions = carrying on business

Impact of Tax Treaties on carrying on a business

Need a permanent establishment to benefit from them: per XI(5) of the Canada-US treaty, it must be attributable & effectively connected with a permanent establishment

Under the UK treaty, must be a UK enterprise to benefit from treaty protection. If the UK business in unrelated to Canadian business, not protected. (Old way of doing things with the US: if didnt have an similar enterprise active in the US, did not benefit from treaty protection.)

Canada-US Treaty Definitions: Art. V - Permanent Establishment:

(1) permanent establishment means a fixed place of business

(2) permanent establishment extended definition

(3) building site is a permanent establishment if it lasts more than 12 months. Even if it is not your own site: site lasts 2 years but present only 1 month = permanent establishment.

Sunbeam Corporation

Sales reps with no power to contract, etc. = no permanent establishment

Panther Oil

Permanent establishment does not mean a temporary one (p. 30)

Canadian Enterprise - p. 30

Rutenberg

NR buying & selling real estate in Canada through an agent over years

Profits held to be taxable - permanent establishment through companys agent

GST

Is a key reason why permanent establishment is an important issue

If carrying on a business in Canada, must register for GST

Rev. Canada considers the PLACE where: contract formed; profits arise; delivery; bank accounts; payment; manufactured; orders solicited; inventory kept; agents i.e.: fact-based

Other tests (p. 31)

Belfour - Italian silk merchant selling in the UK through an agent. Held that business was carried on in the UK even though contract made outside the UK. Look at where payment is made, work done, delivery, etc.

Services - test of performance

Selling equipment to a foreign jurisdiction but service required to install it

If service is ancillary or incidental = not carrying on business

While business exempt, in practice the employees may be taxed

Note (Drew): under a tax treaty need

1. Carrying on a business (1st issue)

2. Permanent establishment

Permanent Establishment Cases

1. Dudney v. The Queen [1988] T.C.C.

Prof. feels that case is substantively right: there was no fixed base However, at some point we need to clarify the difference between fixed base & permanent establishment

2. Cudd Pressure Control [1998] F.C.A.

U.S. enterprise charging themselves a notional rent. Company looked at the cost of rent of a (non-depreciable) machine to third party & charged themselves.

Prof. cant believe it went to FCA - doesnt agree that there could be situations where you may charge yourself a notional rent.

Partnership

Carrying on a business through a partnership

Partnership is the agent: deemed to carry on a business

Entreprise Blaton-Aubert [1972] C.T.C. - joint venture with a Canadian company to build an Expo 67 pavillion. Not a partnership per se but court nonetheless held them to be carrying on a business

Use of agents (32)

Actions of agents deemed to be your own

Thus carrying on a business

Distributorship

Generally not deemed to be carrying on a business

But depends on level of involvement

Firestone: US company did world-wide marketing but UK subsidiary did manufacturing. Distributor sold tires in Canada and placed orders with the U.S. U.S. parent deemed to be carrying on business in UK via their manufacturing agent.

Mere exporting acceptable but more active involvement = carrying on a business

Here, not mere export from UK ( Canada; US played key role

Pullman:

US citizen made loans in Canada through a loan broker. Held that the broker was not an agent since he had no power to bind Pullman. Discretion on involvement with opportunities was entirely in the U.S. (Even though multiple loans made.)

Carrying on a Business Cases

1. Gurds [1985] F.C.A.

Orange Crush case: US set-up company in Canada to deceive Iraq

Shows that even though you can formulate an opinion based on available considerations, can still get caught as carrying on a business in Canada. Tax is not an exact science.

2. Capital Life Insurance [1986] F.C.A.

US life insurance company had only 5 contracts. Essentially only dealing with themselves although eventually wanted to branch out.

Common sense ruling: not carrying on business in Canada

3. Sudden Valley [1976] F.C.A.

IV. Consequences of NR Carrying on a Business in Canada

Calculation of income per s. 115(1)

Source rule - s. 4: where do services & related expenses arise?

Consequences of a branch - s. 230

Loss carry forward: better to have a branch if losses are certain since these losses can be carried forward (p. 35)

Quebec is bound by federal treaties. Ontario has a somewhat different head office rule.

Regulation 105: R withholds 15% of gross amount paid to a NR

Branch tax - reduced from 25% to 5% under the US Treaty

Investment allowance

p. 38 Incorporation of a branch

s. 85 rollover of assets

under 219(1)(l), can have a forward strip. Select a low PUC and avoid immediate tax.

233.1 - must file annual info forms

V. NR Utilizing a Canadian Subsidiary (p. 39)

Withholding tax on everything paid

Thin capitalization

Thyssen Canada Ltd.

Indirect Distribution to shareholders - benefit deemed to be a dividend.

Similarly, s. 17: if a reasonable rate of interest is not charged to a NR, will be deemed to have charged a reasonable rent. s. 17 revisions underway to limit avoidance.

Indalex Ltd.

80.4(2) - Interest free shareholder loans = deemed benefit

Inter-company pricing. s. 69(2) & (3) repealed & replaced by s. 247 (part XVI.1)

Friday, January 29

I. Resident

World income

FAPI rules on CFAs (Controlled foreign affiliate) are important

Concept of residence / NR

Deemed R & NR (Common law & ITA / individuals, corps & trusts)

II. Non-Resident1) Part I (tax on income)

Carrying on business; employment; taxable Canadian property

2) Part XIII (withholding tax)

a means of getting some tax of passive means of receiving income

royalties, dividends

3) Part XIV - Branch Tax

Eg: USCo owns Canco, a separate entity

Can Co. earnings = 100; less 40 tax (Pt I) = Net 60 ( paid as dividends, 5% div. tax (Pt XIII) = 57 net to US Co.

Eg 2: Instead, set up a branch (ie: set up foreign entity in Canada)

Branch earnings of 100; less 40 tax (Pt I) = Net 60 ( U.S. company pays a dividend, thus not caught by Pt XIII [Pd by Canadian to a foreign entity]

Branch tax (219.1 or .2?) usually yields the same result. Tax of 25% but is reduced to the treaty rate, which is 5%. Branch tax paid when money taken out of Canada (via an investment allowance).

$500,000 exemption

ch. 4 - Real Property

Something about real estate that attracts foreigners

Political & economic motives

Opportunities in hot real estate markets

Personal use

Passive investment

Rentals

Property / Business

Gains

Capital / Income

Relevance

Passive = Gains

( Part XIII

Active = Income ( Part I

Gains

At one time, most countries did not tax gains. Led to jurisprudence on income or gains

Then taxed at 50%, now 75%

Adventures = income

Real income is taxable Canadian property

thus, if sold by a NR --- taxed

Characterization

Real estate as investment or business

1 duplex likely an investment / 25 a business

Run by a company = presumption its a business

Scenario: Bill Gates wants to buy property in Muskoka; a 2nd via a Canadian corp; a 3rd via a US corp; a 4th via a chain (USCo owns Canco that has a property)

Wants to sell the property in 5 years. What happens to the gain?

1. BG personally:

Speculative

2(3): carrying on business in Canada

253(c): Adventures deemed carrying on business gain ( back under 2(3)

Provision added in 1991 because of land-flipping in Hong Kong that was not caught under 2(3)(c) [CG] nor was it clearly caught under 2(3)(b) [income from carrying on business].

2. BG via Canadian Corp:

Canadian corp. = Pt 1 [2(a)] & dividend to BG = Pt XIII

What is he sells Canco? Shares of a private R corp.are taxable Canadian property [s. 115(1)(b)].

What if he dies? Taxed on accrued CG at that time.

Can-US treaty 10 & 13. 10:2(b) = 15% CG: 13(3)(ii) = capital gains on shares held in real property ARE taxable in Canada

3. BG via a US Corp:

US Corp = Taxed on CG // If income caught by 2(3) & 253 and branch tax

Net effect of 2 & 3 should be the same, whether its treated as income or CG

#2 = Pt I & Pt XIII v. #3 = Pt. I & Branch tax

Even with CG, branch tax may be on the full amount, not ? (see s.219)

4. BG via a US corp. via a Cdn corp.:

Canco Sale = Ordinary CG tax

Canco div to USCo = Withholding of 5% (direct holding)

Condo in Florida & property in Muskoka

if die, will pay a US estate tax

people now setting up a Canco to buy condo so when they die, they are not holding US property

Treaty provisions designed to stop this: stop estate tax on most individuals, but the wealthiest. Problem: mortgage = taxable benefit for those using Canco

Reverse situation: BG ( USCo ( Muskoka. If BG dies, wont pay tax. 2-3 years ago, shares were deemed to be taxable Canadian property (where shares in NR co. which derives most income from real estate Point: new provision to target the above situation but it affects many other transactions. US didnt like it thus forced to exempt the Americans (4th Protocol)

End result: BG sells shares in USCo = exempt / But taxable in any other country!!

Net effect of 2 & 3 should be the same, whether its treated as income or CG

Pt I & Pt XIII v. Pt. I & Branch tax

Trust

Trustee = Hong Kong bank

Beneficiaries = H.K. residents

Debt with CIBC & HK Bank

Holdings in Canada

1. Building deriving rent

2. Building for re-development

3. Building deriving rent & services

Balance Sheet:

Revenue

800,000

Expenses100,000

Interest

750,000

Loss

- 50,000

Issues:

1. Is the interest of the beneficiaries in the trust taxable Canadian property

s. 115(1)(b)(11): Caught by the extended defn of taxable Canadian property: must be 50% or more

if: Uncle ( BVH Co ( HK Co ( Trust

Each level of shares are taxable Canadian property; pay tax at each level

Applies for 5 years after

Point: this new provision leads to absurd results & unenforceable

2. Is interest payable to the CIBC subject to withholding tax?

Generally, withholding tax where payment = R ( NR

* But, secondary withholding tax under 212(13.2): where NR business carried on principally in Canada

(s.212(13)(f): interest payment NR ( NR if paid with respect to a secured loan / mortgage)

(Is there a s. 212(1)(b)(7) exemption?)

3. Is interest payable to the HK Bank subject to withholding tax?

If carrying on business in Canada, under 2(3)(b) - preferable

If rental, subject to withholding tax - not desirable, since on gross amount

Can view the whole of the trusts activities as a business

4. Is the trust carrying on business or is it (rent) subject to Pt XIII tax?

Dont want to pay 25% withholding tax on gross amount

To be sure (protect yourself), s. 216 allows you to file an election deeming you to be carrying on a business

Regulation 805: Dont have to pay Pt 13 tax if paying Pt 1 tax

5. Do the thin-capitalization rules apply to deny the deduction of the interest?

Only applies to corps resident in Canada

6. Can the loss be carried forward?

216: taxed as though under Pt 1 but no deductions in computing taxable income

No loss carry-forward if operating under s. 216

7. Is there a capital tax?

8. If everything sold & $1M gain realized, is it taxable in the hands of the trust?

104(6) & (7)

75% tax, caught under 2(3)(c) / taxed at 29% per s. 122

104(2) Taxed as indivs

116 certificate must be obtained

9. What happens when that gain is then distributed?

1. 212(1)(c) withholding not applicable

2. No secondary withholding applicable

Seems you can distribute tax free

NR beneficiaries only taxed once they sell their interests

But, has their been a disposition of the trusts interests? (We wont look at this)

Friday, February 5

Mintz Committee

Set up by Paul Martin in 199x budget

Martin distanced himself from many of the recommendations (lower corp. tax, fewer subsidies, etc.)

Did a good job in intl area

1. Assignment (30%)

Pick-up Monday after 10, return Monday by 4.

No policy work ( 2nd assignment (35%)

Course more mechanical to date

2 complicated fact situations with specific questions

Brief sentence/paragraph form.

Act & treaties to back up

2. Assignment 2: March 15-22 - 35%

3. 48 hour take-home - 35%

Ch. 5 Non-Resident Withholding Tax

Application

R ( NR

Exceptionally: NR ( NR

Not R ( R

Rate

25% flat rate on gross amount paid; payable immediately

Rate reduced by treaties: 15 / 10 / 5 / 0%

Exceptions

Government debt

Corporate debt

Others (well see later)

Part XIII

Obligation of the payor

Withhold amount & remit to government

Nestle Enterprises Ltd v. MNR [1991]

Did the TP remit withholding taxes owing forthwith

As an administrative practice, Revenue expects payment on the 15th of the following month

Here, payment made Jan. 17th, mailed cheque Feb. 14th but not received until Feb. 20th Went to court & won

Only case that goes against the 15 day rule

s. 212(1) - Every NR shall pay an income tax of 25% on any amount that a person resident in Canada pays or credits, or is deemed by Part I to pay or credit

(a) deals with management fees

(b) deals with interest

(c) etc.

each par. deals with a specific payment

Application of s. 212:

1. Payment

2. Credit

see case law

3. Deemed

Types of payments

Generally applies to passive income

Use of property, trademarks, royalties, etc.

Must differentiate between different types of income: CG, business income, dividends

s. 212 (a) Management fees

212(4) defn / (a) & (b) = what is not covered.

212(4)(a) - eg: Fee of $100,000 paid to Bain & Co. in the U.S. Per s. 212(4)(a) defn of management fee, this is not caught by the ITAs narrow definition.

Not caught under Pt 13 but what about Pt I?

Would we have to withhold under Reg. 105? (Withholding on account of tax: hold now then figure out if any tax is owing.) NO

Revenue wants intl companies to allocate their time & revenue by country and show that its reasonable.

212(4)(b) - No withholding if its for a specific expense.

Scenario: Canco pays 150,000 to US parent. Covers 100,000 in specific expenses & 50,000 profit

1. Part I:Not carrying on business in Canada: no Pt I tax

2. Part XIII: management fees subject to withholding but 100,000 exempt per 212(4)

3. 50,000 would be subject to s. 212 withholding tax of 25%

4. Look to treaty to see if its reduced: Canada-US. Art. VII on business profits: shall be taxable only in the US unless carries on a business in Canada through a permanent establishment.

5. Conclusion: Not taxable in Canada, thus no withholding taxes.

Scenario 2: Where amount paid to US parent is inflated to avoid Canadian taxes

If US parent is in a loss position & Canco making a profit, can save the whole 45% tax on the amount transferred

Will be treated as a deemed dividend under s.15(1). Per s. 214(3), this will be treated as a deemed payment (thus subject to withholding taxes).

Much money to be made in transfer pricing (raw materials, manufacturing, etc.) but most large companies dont want to get caught doing something wrong & thus play by the book. More evasion among small businesses, owned by managers.

Steps

1. Management fee, subject to s. 212?

2. Does it fall under the 212(4) exceptions?

3. Else, taxed under s. 212?

4. Treaty provision to reduce or eliminate the 25% withholding tax?

5. For those amounts qualified under a s. 212(4) exception, was the amount reasonable? Or is it in fact a shareholder benefit per s. 15(1); thus treated as a deemed dividend under s. 214(3) and taxed under the treaty at 5%.

Competent authority rules under the Treaty settles those cases where the two countries do not agree

s. 212(1)(b) - Interest

Interest subject to withholding

But many exceptions:

(i) Pd by NR investment corp

(ii) Interest on govt. debt

(iii) Currency other than Canadian

(vii) Loan agreement if a corporationrepayable within 5 years

Discussed in Mintz Report

s. 212(1)(c) - Estate of Trust Income

Canadian trust to a NR beneficiary

s. 212(1)(d) - Rent, Royalties, etc.

Right to use; information; scientific services are included in withholding tax

Exceptions to inclusions

Rents: 25% of real estate doesnt make sense. Under s. 216, will elect to be taxed on the net basis. But if rental income in part on carrying on a business in Canada, caught under Part I, not Part XIII (Reg. 805: no Part 13 tax where part of business carried on in Canada.) ( Carrying on a business includes staff required to run an office building.

212(2) - Dividends

25% withholding on dividends

BV Co (Dutch) --- Canco

10,000 put in at start-up (stated capital)

40,000 more cash over time ( RE now 50,000

How can this be taken out?

1. Dividends = 40,000

2. Reduce capital = Under s. 84, tax free return of 10,000

or

3. Redeem shares = 50,000 ( 40,000 of which is a deemed dividend

Deemed dividend subject to 5% withholding tax, per treaty

CG taxable under the Act but exempt under the treaty - more beneficial

(All of this is leading to 212.1)

Now BV Co decides they will sell Canco to NewCanco for shares

At a Cost = 10,000; PUC = 50,000

Cost = 50,000 = PUC

By setting up NewCanco, get a tax-free intercorporate transfer

s. 212.1 - Anti-avoidance rule against surplus stripping

The amount by which the payment exceeds PUC is assimilated into a dividend

Therefore, caught under withholding tax

If US Co. wants to buy Canco

US Co: PUC = 10,000 but FMV = 50,000 (same as Canco)

Problem: withholding tax on dividends as it tries to extract the value from Canco

To get around this, create Acquisition Co, inject 50,000 (high PUC) then merger it with Canco to get money out tax free

Compare:

a) US Co owns Can Co

ACB / Cost50,000

PUC

10,000

FMV

50,000

b) US Co owns Acq. Co

ACB / Cost50,000

PUC

50,000

FMV

50,000

Acq. Co then buys Canco and merges with it

In vertical amalgamations: PUC is the PUC of the buying corp.

Conceptually, not unlike creating a corp. for butterfly transactions?

Canada-US Treaty

5% withholding on dividends

0% on Royalties (Policy: better flow of information, patents)

Friday, February 12

NROs - Non-resident owned investment corporations

NR owns

Stock in Bell yields 100 CG - not TCP thus no tax; 25% withholding, reduced by treaty

Bombardier bonds yields interest payment - 212(1)(b)(vii); no withholding

Private company stock yields TCG (CG) - TCP; 25% withholding, reduced by treaty

Interest on bank account yields interest - 25% withholding but issue a T5, reduced by treaty

Assume each yields an income of 100 for the investor =400

Rationale for NROs: Cold War sentiment to shelter assets in R cos.

Normal Canadian co doesnt make sense = tax burden (e.g.: Can Co = taxed domestically then subject to withholding as well)

NRO allows an NR to Canadian assets or investments and achieve about the same results as if they were held directly

NRO must be held by a NR

Exception: Unless its a trust & all beneficiaries are NR

90 day election period from the day the company starts its business

133(8) - Defn: no more than 10% of revenue from rent; principle business not making loans

133(3) - Tax rate = 25%

133(1) - Computation of income

No deduction of interest

Only taxable CG is TCP

Taxable income in example above is all but Bell

Otherwise, Bombardier interest on bonds would have been exempt but the Can Co would have been taxed at (?). Thus, not a perfect mechanism.

Result: 400 gross less 75 tax = 325

But: Year 2 - when a dividend is paid out, the NRO gets a refund (full $75) but the NR pays 25% on dividend, less treaty reductions.

[Like the Canadian investment co.; tax the investment co. holdings until dividends pd, to prevent deferrals.]

Scenario: Receiving royalties in Bahamas from various companies, at a rate of 25% withholding. If interpose a Canadian NRO, reduced by treaty to 10%. Dividends then paid by NRO to Bah. (but subject to 25% withholding!?)

Somehow, NROs were used to reduce foreign taxes (he cant remember how)

NROs no longer benefit from Canadian treaties - Made Canada ~ tax haven US Co owns an NRO & a Can Co

US puts 100M into NRO, loaned to Can Co @ 10% (10M)

10M interest, assume full deductibility of interest

NRO interest received is then paid to the US at a total of 10% withholding

Structure eliminated by the 3rd Protocol in 1995 by raising withholding to 15%, thus matching the 15% that would be withheld if the Can Co paid US directly (Note: Until 95, US Treaty re interest was 15%, not 10% as it is now.)

Mintz suggest that NROs be abolished

Ch. 6 - Withholding Tax on Interest

No WT on interest payable by an NRO

Part XIII: 212(1)(b)

NR pay 25% WT on interest

Exceptions

212(1)(b)(ii)(C) - bonds, debentures, notes or similar obligations

(I) of or guaranteed by the Government of Canada

(II) of the govt. of a province

(III) municipality

(IV) Corp 90% govt. owned

[etc.]

212(1)(b)(iii)(D) - NR with a Canadian bank account not repayable in Canadian dollars, earning interest

212(1)(b)(ii)(E) -

Canadian owns UK branch which pays 10% interest to Midland UK. Can Co is paying the interest to a UK branch (R ( NR) thus would be subject to 25% WT, reduced by treaty

This provision says that is Midland is AL, no WT

Allows Can Co to operate a branch abroad

n/a when the loan is repaid in Canadian dollars Practically, will tend to form a corporation abroad

Problem: What is borrowed from Midland in Canadian dollars?

25% WT prima facie

Treaty?

2. 10% maximum in the country where interest arises. But interest not arising in Canada thus not applicable.

7. As a general rule, interest arises where the payer resides. However, where the person paying the interest has a PE in the other country, which bears the interest, it shall be deemed to have arised in the UK. Break at 11(2) thus n/a (Still at 25% since still R ( NR)

But 25% doesnt make sense with a treaty country

US Treaty has a Other Income provision at Art. XXII:

1. If items of income are not dealt with elsewhere, it will only be taxed in the other country unless it arises in Canada. [Since Art. XI did not deal with the interest payment at issue, would look to such a provision. Unfortunately, the UK Treaty does not have an Other Income clause.]

Conclusion: would only be taxable in the UK = 0 WT if under US Treaty. [The argument to be made is that Art. 11 of UK treaty does not encompass this situation & thus is not dealt with.]

What to do in UK? 25% with a treaty partner just because borrowed in Canadian dollars? Ans: write for a technical interpretation, given that there is no policy rationale for the apparent outcome. Rev. Can. responded that per Art. 11(2) Canada can only tax at 10%. If outside scope = 0% (like the 212(1)(b)(ii)(E) exception)

Point: tax where interest arises.

Singapore resident buys a Canadian condo with loan from UK bank.

10,000 - Rents out condo

9,000 - Interest

1,000- Other expenses

Net = 0

Elect under 216 to pay tax on a net basis (=0)

212(13)(f) secondary WT - where NR ( NR and int. deductible under Pt I

Only applies if its secured by the real estate

Setlawke was always concerned that Rev. Can. would say that the loan is effectively secured (look-through).

What if it is held that 212(13)(f) applies

Look to treaty with UK (Art. 11) for reduction

Art, XI(1) - Payer must be R of Canada; 212(13)(f) deems the Singapore indiv. to be a R for this purpose. Doesnt make you a R of Canada for purposes of the treaty!!

If not a R, then payment does not arise in Canada, as required under (1) of the treaty

Setl: Better view - (13)(f) probably wont apply but if it did, payment not deemed to have arised in Canada under treaty - despite deemed R per ITA * Read treaty defn of R.

Argue then, that XI(2) is all-inclusive & that Canada can only apply when it arises in Canada212(1)(b)(vii) - 5-25 Rule: Cant be obliged to pay more than 25% of the principle with 5 years

Permitted to pay excess, however, as a term of default

Also okay where the payback is triggered with a change to the legislation, change in control

AL for the exemption to apply

Closing par. of (1)(b) - deduction n/a if its a participating loan (ie: interest is calculated as a percent of revenue, or value)

Friday, February 19

Chapter VII: Canadians doing business abroad - Foreign Tax Credit

126(1) - Non-business income tax

126(2) - Business income tax

Significant changes introduced to ss. 17 (transfer pricing) & 126

FTC

e.g.: RRSP invested in Alcan = Canadian dividends. If in Alcoa (US), 15% US withholding on dividends. No credit here since not paying Canadian tax on an RRSP.

126(1) - If invest as an individual in

100 from Alcan = 38% (53% top rate)

100 from Alcoa = 30% withholding reduced to 15% under treaty.

But include the entire 100 when computing world income, less 53% tax.

But already paid 15% = 68% total

DTC to offset: Pay 15 to US, owe 53 to Canada less 15 already paid = 38 in Canada.

Above is the system for non-business income tax (NBIT): 126(1). But the results are the same for corporations:

126(2) - Canco with a UK branch that earns a profit of 100

UK tax of 40% = 60

Assume a Canadian tax of 45% on the 100 = 100 - 40 - 45 = 15

Instead, Canada credits the 40 and takes 5

All the details in the ITA merely deal with aberrations of the above.

3 Possible Systems

1. Credit system (from taxes)

e.g.: s. 126(1)-(2)

2. Exemption system

e.g.: FAPI & 113(1)

Canco has foreign subsidiary in the UK and a branch.

The branch in taxed under 126(2) credit system.

What happens when you instead have a company? Not taxable in Canada since not R but pays a dividend to Canco

100 less 40% tax= 100 - 40 = 60

UK WT of 10%= 60 - 6 = 54

126(7) - non-business income tax defn

is what is not in defn of business income tax

126(7) - business income tax

Business carried on by the TP in a country other than Canada

The money received as a dividend from UK Co is not business income tax but rather a non-business income tax

126(1) - FT deduction

R may deduct from income:

(a) non-business income tax except that paid by a foreign affiliate

95(1) - Foreign affiliate defn

- TP equity not less than 1% and total equity of TP & related not less than 10%.

Per these provision, there are no FTCs available here.

Reason: 113(1) FAPI rules provide an exemption (eliminates the need for a credit). Essentially, allows Canadian Cos to carry on business through a corporation that will pay taxes in that country & Canadian taxes on dividends.

i.e.: ACB earned by an affiliate in a treaty country will already be taxed appropriately in that jurisdiction & wont tax again.

Affiliates: wont include widely held corps like IBM

3. Deduction system (from income)

s. 20(11)

Section 17 - Loan to NR

Where corp. R in Canada made loan to NR and was outstanding 1 year or more without interest, the corp. will be deemed to have received interest at the prescribed rate

1)

US

|

Canco

|

| NR loan

|

Belgium ( loan to Canco

17(3)

If a subsidiary controlled corp. [248(1)] & money used in the business, its okay

If there was a B Co owned by Belgium Co, 17(1) WOULD apply as a 2nd tier sub not caught by definition

2)

US

|

Canco

|

| Sale of property

|

Belgium

Balance of sale owing; s. 17 n/a

3)

US

|

Canco

|

| 100M put into Belgian co (shares)

|

Belgium ( Loans money to US Parent

Looks like a loan from Canco to US Co; which is a deemed dividend [15(2) shareholder benefit & 214 deemed dividend = 5% WT]

Loan by a Canadian corporation

Rev Canada may decide not to pursue under 17 where 13 has applied instead (WT)

Setlawke Structure:

US Co ------------------------

|

|

| 65 M debt to US Co| 100% ownership

|

|

Canco

Norway (loan stops at N but US co owns 100% N)

|

|

|

|

Belgian Co -----Loan (----

US Co owns

100% Canco

100% Norway Co

50% Belgian Co

Canco owns 50% Belgian Co

Belgian Co has 10M in income

Assume FAPI n/a to US COs holdings of B Co

Above structure will be look at to study 3 different issues:

1. FAPI rules (next week)

2. 17(1) as modified

3. Transfer pricing

Norway loan

17(1) n/a since Canco is a debtor, not creditor

65M @ 10% = 6.5M / year to US Co in interest (deductible from income)

15(2) n/a: would be a stretch to characterize loan as a loan from Canco

Concern: 17(1) as modified could affect situation by attributing the loan to Canco

Transfer Pricing - example 1

Canco sells 50 tons at $100/ton to Canadian clients

Canco sells 50 tons at $80/ton to US Co

Canada loosing out at 50 x $20 = 1000 of taxable income

How to justify? Expenses and other work required in Canada may be higher whereas could US Co may be doing the work internally.

Usually ends up in the hands of economists to assess and corps. will eventually come to a settlement with Revenue Canada.

Point: is income being shifted between companies? What is a fair price? ( thats the issue in transfer pricing.

Transfer Pricing - example 2

UK selling ingredients for a prescription product

What is an acceptable mark-up?

May have paid $8 for the ingredient but what can the company charge as an equivalent to an AL royalty? (etc.)

Conclusion:

At the end of the day, the issue is what would an AL party have paid?

Only 1 case: IndalexPaper Remarks

Provide short answer, then long answer

Soujourning rule applies where present in Canada, not residing. If Rising Star resides in Canada as of June 1, he is not subject to soujourning rule; rather, he is resident in Canada.

Ch. 8 - F.A.P.I. (ss. 90-95)

Purpose

Taxation of passive income earned by foreign corporations. Goal is to avoid setting up foreign companies to earn passive income. Otherwise, could have indefinite tax deferral.

1. X earns $100 in CIBC or $100 in Swiss bank: Canadian resident individual is taxed on world income thus, no difference in tax treatment.

2. X owns Canco that earns $100: Same result

3. X owns Bahamian company that earns $100: Want the same results here to achieve neutrality.

Anti-deferral / attribution regimes used all over the world to prevent such blatant avoidance techniques.

What about active business income?

Canadian government wants to encourage Canadian business to operate in other companies on the same footing as their competitors in that jurisdiction.

Inter-affiliate dividends?

Can Co

|

Bahamian Holdco

/

\

\

US Opco UK Opco Berm Co (non-treaty co.)

1. Operational profit not FAPI (=ABI).

2. Dividends to Bah Co also not FAPI. Any inter-affiliate dividends are not FAPI.

3. But interest earned on dividends reinvested by Bah Co is FAPI

4. When Bah Co pays Can Co?

Exempt Surplus: ABI earned by a co resident & carrying on business in a treaty country. (Dont want to subject US Co & UK Co to operational taxes above what is paid in those countries.)

Taxable Surplus: Includes ABI earned by a foreign affiliate that is either resident or COB in a non-treaty country. (Berm Co not subject to taxes; thus taxable once money brought back to Canada. Rate = difference between Canadian & Berm rates.)

Inter-affiliate dividends are not FAPI.

If it was FAPI originally, the accrual was previously caught

If it wasnt FAPI originally, why would it be caught by inter-corporate movement

NOTE: Inter-affiliate here is referring to FOREIGN affiliates. Thus Bah ( Can Co not included.

Where Can Co is paid a dividend, it is subject to taxation BUT relief from double taxation under s. 91(5) for previously taxed FAPI.

91(4) also grants relief to the extent FAPI paid a foreign tax

Levels of FAPI taxation:

1. FAPI earned in UK taxed in that country

2. Attributed to Can Co & taxed - 91(4)3. Paid to Can Co as dividend & taxed - 91(5)1. Non Foreign Affiliate

Less than 10% ownership

2. Foreign Affiliate

Where there is 10% or more ownership in a foreign company

3. Controlled Foreign Affiliate

FA that is controlled (de jure) by the taxpayer

49% is a FA but not a CFA

FAPI only applies here: (1) need to cut it off somewhere and (2) this is where TP can easily influence affiliates behaviour.

91(1) Amounts included from FA

Proportion of share in a CFA

51% = Included 51% of any accrual

Can Co

|

B Co3

|

B Co4

Value of 51% of B Co3 share includes value of B Co4

1. 95(1) defn of FA

NR corporation in which:

(a) TP holds 1% or more

(b) Total in excess of 10% (directly & via related persons)

Related: spouse, sibling, children

2. 95(1) defn of CFA

Controlled by

(a) TP

(b) TP & no more than 4 other Canadian residents

To get around this, would need 10 people at AL with 10% each

(c) Not more than 4 TPs resident in Canada, other than the TP

(d) A person with whom TP in NAL reln, OR

If 6 people NAL each had 10% = caught here

(e) TP and a person or persons NAL

NOTE: May be NAL under CFA but if not a FA under the defn because not related, safe

Ludmer Case (76)

Ludmer

+

Arnold Steinberg

\

/

Jersey

They both had 9% ownership; not a FA

Invested 100M & earned 10M in dividends

Not FA thus no FAPI & money could be kept offshore

Ludmers co borrowed 10M to invest & paid 1M interest

Issue: can the interest be deducted?

s. 94.1 introduced in 1985 to try to block this

Effect: if principle reason was to avoid tax, will be assigned a notional income, regardless whether a payment was made.

3. 95(1) defn of FAPI

(A + A.1 + A.2 + B + C) - (D + E + F + G)

where:

A: FAs income for the year, other than CBI

B: Taxable CG, accrued after 1975 (since FAPI rules introduced in 76)

D: Losses

ie: FAPI is income from property (other than ABI) and CG less losses

95(1) Defn of active business of a FA

Business = active business, unless

1. Investment business

2. Deemed FAPI

s. 125 case law of what is an active business has been very generous with towards TP (low threshold)

X

|

CFA

|

10M

|

/ |

\

MS SB

G

Thus AB here excluded investment businesses like the above to ensure its caught by FAPI

95(1) Defn of income from an active business

Includes any income of that affiliate that pertains to or is incident to that business

e.g.: seasonal business = receipts invested for 3 months per year

Inter-affiliate payments

a) Real FAPI

e.g.: straight interest

b) Deemed FAPI

e.g.: investment business

e.g.: Setlakwe

|

Bah Co ( Payment for sevices

95(2)(b) - Where Bah Co provides services but services are performed by a person resident in Canada (X), will be deemed FAPI

c) Deemed ABI

Can Co

/

\

US LLC ( 10M loan ( US Opco

US Opco = ABI

US Opco pays interest to US LLC

US LLC is a single purpose company: it earns interest

Is this FAPI? Prima facie, seems it is.

Without the payment, would have a higher ABI which is not FAPI, thus why would this be FAPI?

Thus, the payment is deemed not to be FAPI; deemed ABI to US LLC as well

Key element to the way that Canadian companies finance their operations. Called a double-dip structure.

Made more difficult in 1994.

Friday, March 19

Bare bones of FAPI regime

s. 90 - dividend from foreign corporation included in income

s. 91 - include FAPI in income

s. 95(1) - defns of FA, CFA, FAPI, excluded property, investment business

investment business defn: to overcome the low threshold the courts have found to qualify as ABI

s. 95(2) - deemed FAPI, deemed ABI

s. 113 - deductions for dividends: exempt surplus (exemption), taxable surplus (credit), preacquisition?

Exclusions from an inclusive FAPI regime

FAPI

Passive income

Taxable c.g. other than

FAPI = Attributed currently

ABI = No immediate attribution

ABI goes into surplus accounts

(1) exempt surplus - ABI of a foreign affiliate COB, resident in a treaty country

(2) taxable surplus - Taxed in Canada but relief given for foreign tax paid

Regulations

5900 ff.

see later in notes

Note on IBC

Barbados Corps Act modelled after Canadas

But Barbados IBC provisions are for companies not owned by residents of Barbados (that is not operating in Bb?)

Example

CanCo

|

100%________|________100%

|

|

LLC (US)-loan(

US Co

Interest inc. 5M

|

______|_________

|

|

100,000,000

- ABI of 10M

portfolio

- Tax of 4M

- 8M income

- Net = 6M

- 3M tax

- Net = 5M

ANALYSIS

1) The 2 US companies CFAs

2)ABI is not attributed on a current basis (Canada taxes residents & FAPI; this ABI income is neither)

3)6M net goes into exempt surplus:

Reg. 5907(1) definitions;

Reg. 5907(11) [see list of countries in Green Act fine print] - countries on this list are exempt surplus (in principle, these should all be treaty countries). New Regs. at 5907(11) eliminates the list and replaces it with notion that a designated treaty country is one that has a comprehensive treaty with Canada.

Reg. 5907(11.2) FA deemed not to be a resident in that country UNLESS (a) it is resident of the country for purposes of the treaty [ie: US Co, taxable in the US, is resident of the US - a treaty county].

Barbados Treaty

1. IBC owns Canadian ( payments to IBC subject to 25% withholding tax

Treaty: cant benefit from the treaty if you are an IBC

2. Canadian owns IBC ( no withholding tax in Barbados but concerned about residency. ABI should normally be part of exempt surplus, BUT regulations say otherwise: Reg. 5907(11.3)(a)-(d):

(a) Is it resident in a treaty county ? IBC not a resident of Bb under treaty (excluded);

(b) The affiliate would be a R of that country if the affiliate was treated as a body corporate (ie: While in Canada, a corporation is a corporation, such is not the case in the U.S. - a LLC may not be treated as a body corporate in the US; NS unltd liability corp. treated as a partnership in the US. Thus, the LLC in the above diagram is not treated as a corp in the US. Canada had to respond to this anomaly).

(c) This provision is for Barbados!! - Agreement pre-1995 and would be R but for a provision on the agreement [carve-out provision for Barbados IBCs]

(d) .

Since we fall under Reg. 5907(11.2)(c) - this is exempt surplus

Definitions - 5907(1)

Earnings from a FA is ABI before tax computed under US law = 10M above

Net earnings from a FA is the amount of earnings from AB less taxes = 6M above

Exempt earnings is the total of all amounts each of which is (d) after 76 & is R of a designated treaty country. = 6M

exempt surplus includes exempt earnings = 6M [A - B formula]

If the 6M brought back into Canada, it is brought into income under s. 90, but full deduction under s. 113

Bb Treaty

NA to IBCs, therefore IBC not R of Bb

Reg. 5907 -

4) 100M portfolio above: 8M income, 3M tax = 5M net

see 95(1) defn of active business: other than investment business / if 10 people are managing it, could it be an active business? Perhaps, but then is it an investment business

95(1) defn of income from an active business: includes any income incident to that business

Thus, 1st ask if it is purely passive income. If so, its FAPI. If not, is it ACI (incidental or not)?

If we assume that it is not incidental business income & not property income per se since there are 6 people managing this portfolio.

Is it an investment business? Defn at 95(1) - IB where principal purpose is to derive income from property, UNLESS it is established that the business is (a)(i) the lending of money or and (B) 5 or more full time employees

Could buying bonds be considered lending money? If can fall in here, not an investment business. Therefore, ABI & escapes FAPI rules.

If FAPI, the net amount goes into taxable surplus account

5) LLC

5907(11.2) says that despite the fact it is called a P in the US, Canada treats it as a corporation.

5M is passive income - prima facie FAPI (but it is not)

But is it an investment business

95(2)(a)(ii) - in computing income from an active business, shall include (deeming) amounts related to an active business [in U.S., making 6M ABI from US Co + 5M from LLC] the whole amount in the US is used in one active business (since money is loaned to US Co). If the 5M were FAPI, it would only compel a merger of the 2 US companies in order to become exempt.

If the interest income earned is from LLC is due to the loan to US Co employed to earn ABI, the interest expense is deducted from US Cos income and treated in hands of LLC as ABI. [see s. 95(2)(a)(ii)]

See defn of earnings at Reg. 5907, par.(b): Relevant since US Cos interest expense is deductible

Ans: 1st Deemed ABI under 95(2)(a)(i) - 2nd look to Regs which says that you include the amount in earnings (income);

95(1)(2)(a)(ii) says its included if its deductible by US Co, which it is.

Other points

Since LLC is a flow-through entity, US with withhold 10% of interest payment by US Co to LLC

Transferred under s. 113 tax free (LLC to Canada)

CanCo

|

CFA

ACB = 100

FMV = 175

1. If sell, results in a c.g. of 75

2. What if CFA gives a div. to CanCo? = Tax-free inter-corporate dividend & FMV decreases by 75.

3. If it doesnt 93(1) allows the 75 of the 175 to be deemed a dividend

CanCo

|

USCo1

| (60)

USCo2

Dividend: USCo2 ( USCo1 of 60 from one exempt surplus account to the others exempt surplus account

What if sell USCo2?

FAPI defn includes c.g. except excluded property

Excluded property means active business assets - not part of FAPI. Thus exclude shares of foreign affiliates that are active businesses

94.1

CanCo

_|_____________________________

CP

Trimark MF

Casurina fund (T-Bills)

C. fund was a tax avoidance (deferral) mechanism; no dividends but large c.g. later on. If held 3%, not a FA or CFA (outside FAPI rules)

As this spread, 94.1 introduced: if the principal purpose was to defer tax, then notional income of 100% will be attributed x rate of interest

Key: is this a reasonable conclusion (with Casurina it is since targeted Cdns but a world-wide mutual fund?)

Point: 94.1 was meant to deal with C. but big question on how it would affect a Bermuda mutual fund vehicle that targets investors world-wise. TP would argue its a bona fide inv

See budget re commentary & rules on foreign trusts (NR trusts & 94.1 will be changed by this budget)

ch. 10 - Foreign Affiliate Share Exchange & Mergers

BCE

__________|_______________

Bell

Nortel

Teleglobe

With Ameritech deal, restructured tax-free via s. 85(1) rollover:

BCE

|

Bell

__________|_______________

Nortel

Teleglobe

Domestic Transactions

s. 85- Property to a company for shares

s. 87- Merger of Cancos

s. 86 - Reorganizations

s. 88(1)- Liquidations / wind-up (must own 90% of subsidiary)

FA Transactions

85=85.1(3)

87=95(2)(d)

85=95(2)(c)

s. 85.1(3)

1)

CanCo

CanCo

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FA1

FA2

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FA1

Originally: ACB = 100, FMV = 175

Could FA2 issue $150 note & 25 shares & achieve a tax-free rollover?

85.1(3)

(a) Cost of property = FMB

(b) Cost of shares received by FA2 is deemed to be the amount that the ACB of FA1 shares (100) exceeds 150 = 0 ACB for FA2 shares

(c) Proceeds of disposition = Non-share consideration + cost of shares 150 + 0 = 150

(d) Cost to FA2 of share = TPs proceeds of disposition = 150

After:

CanCo shares of FA2: FMV = 25, ACB = 0 [+ note outstanding of 150]

FA2 shares of FA1: FMV = 175, ACB = 150

$50 c.g. realized + $25 latent [outright sale would = $75 c.g.]

As a rule, cant transfer property from a Canadian corporation to a foreign corporation. Can transfer property from one foreign affiliate to another however - but only tax free to extent non-share consideration does not exceed ACB.

2)

CanCo

CanCo

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|

FA (U.S.)

Berkshire

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FA

Getting back 2% of Bs shares

No rollover, since B is not a FA of CanCo

3)

CanCo

CanCo

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USCo (5%)

Berkshire (2%)

|

FA

Transfer of 5% USCo to 2% B

NA since USCo not a FA

4)

CanCo

|

BermCo (100%)

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USCo (100%)

If put in 100,000 but sell for 2M

If USCo is an active business & BermCo sells USCo shares, the c.g. is not FAPI

Also deferring recognition of c.g. in Canada.

5)

Mr. X

Mr. Forlorn

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CanCo

F Co Can

|(100%)

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BermCo

| (50%)

|(50%)

|

USCo ----------------------------------

Would recommend that Mr. F set up the same structure as Mr. X (i.e.: transfer FCo shares of USCo to a newly created BermCo for shares in BermCo) to avoid immediate recognition of c.g. if F Co Can decided to sell USCo shares. {i.e.: Goal is to benefit from the excluded property rules)

Can this be done via 85.1? No ( 85.1(4) Exception: May not use this rollover where the goal is to transfer the property into excluded property as a series of transaction to sell USCo, exempt from c.g.

Excluded property includes shares but cant use 85.1 to create this opportunity prior to a sale that would otherwise be taxable.

Note: not always good to set up a BermCo since high dividend flow would be subject to a 30% WT as opposed to a 5% under the treaty.

95(2)(c)

CanCo

|

FA1

FA1

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FA2

FA3

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FA2

One FA disposing shares of second FA to another FA

Otherwise, would have a c.g. & FAPI

85.1 talks about a TP thus need 95(2)(c)

95(2)(d) - Foreign merger

CanCo

|

FA1

/ \

FA2FA3

87(8.1) - defn of foreign merger: FAs each resident in the same country. If within defn, 95(2)(d) simply refers you back to 87(8).

CanCo

/ \

FA1FA2

95(2)(d) - FA1 must be a FA. Doesnt say that FA2 & FA3 have to be FAs (could have a 9% interest).

Ch. 11 - Offshore Trusts

H.K. Parent ($100M)

/ \

Canada US (children)

Children study in N. America, marry & obtain citizenship

Same scenario for wealthy families in South America, Middle East

How is the wealth transferred & held?

FAPI rules apply to corps, not NR trusts

94(1) - re offshore trusts

Where:

1. Canadian has put money into an offshore trust, and

2. Canadian related beneficiary (spouse, children)

the NR trust is deemed resident in Canada.

1. HK R

( Trust ( HK kids

- 94(1)(c) not applicable

2. HK R

( Trust ( HK kids in Canada- 94(1)(c) not applicable

3. Cdn R

( Trust ( NR kids

- 94(1)(c) not applicable

4. Cdn R (< 5 yrs) ( Trust ( Cdn kids

- 94(1)(c) not applicable (need > 60 mths)

HK residents came to Canada because of an affinity for Canada and the benefit of not paying tax for 5 years

Point: trusts are flexible instruments that afford the opportunity to obtain tax advantages

Question: Which of the three parties should pay tax?

HK = nobody

US = x, Cda = y

1. Saudi Arabian comes to Canada with 1B & earns interest

Taxed on interest

2. Saudi Arabian comes to Canada & sets up a NR Trust with Canadian kids as beneficiaries

Per p. 137, taxed on Canadian source & FAPI under s. 94(1)(c) & (d)?

s. 94 in place since 1976 but big changes on he way

Paul Setlakwe sees 3 problems in the area of intl tax

1. Extension of TCF definition (HK res. shares in HK co earn income principally from real estate)

2. Departure tax

3. NR trust rules

s. 94 - 2 Conditions

(a) Canadian beneficiary, and

(b) Canadian related settlor

If conditions exist, then s. 94 applies:

(c) Discretionary trust (trustee has discretion re: distribution, etc.) is deemed to be a resident Canadian trust

But taxed on Canadian sourced income & FAPI

(d) Non-discretionary trust is deemed to be a corporation

FAPI attributed to each beneficiary in accordance with their share of entitlement

Implications

Not applicable where either the settlor or beneficiaries are NR

per 94(1)(b)(i)(A)(III) - Settlor must be resident in Canada for 60 months (5 yrs). Thus, not until the 5th year that the trust will be deemed resident (at 60 months, deemed R for that whole calendar year as a trusts fiscal year is the calendar year). Effectively gives a 5-year break for immigrants (is one reason why Canada has attracted immigrants)

Trusts are a flow-through vehicle: Taxed if they do not distribute income & credited to the extent that they do distribute.

But can avoid taxes completely for 5 years by keeping it in the trust. Leave it in and distribute is after 5 years as a tax-free distribution of capital. (However, merely waiting 1 day until the new calendar year to convert income to capital may be targeted by Revenue Canada.)

Assume the immigrant settlor dies 1 day before 60 months.

Settlor must be resident for 60 months therefore no caught by Canadian taxation

Assume Trust eanrs 10M directly & another 5M from a CFA (FAPI). What happens when it becomes a resident?

Look at par. (c)(i) - deemed R & taxable income is

(i) TCP Gains

(ii) FAPI

(iii) FAPI of its CFA

94(3) - Deduct from trusts income, amounts paid to a beneficiary

Important rule

Assume NR Trust has 10M in income accruing but beneficiaries = 1 Canadian & 1 Hong Kong

Taxed on the entire amount accumulated

Unfair result but too bad

If instead distributed entirely to the HK beneficiary = no tax!

If started with 10M, have 30M accumulated income and then distribute 20M to each beneficiary.

Assume trust never paid tax (never filed)

Under 94(2), the beneficiary is jointly & severally liable for tax obligations.

Also liable for penalties, interest to the extent of his share of the distribution

Point: Canadian pays on behalf of both beneficiaries. Beneficiary can then turn around and sue the trustees. Unique in the world. (Is a problem since a number of Canadian trusts were not complying with the law)

Avoidance opportunity by distributing income to HK and capital to Canadian?

Investment Banker ( NR Trust ( International Red Cross

Sets up this trust with the power to add beneficiaries

Legally not a sham but unfair to be able to set up an offshore trust and not pay tax

Therefore changed the law: 248(25) - Beneficially interested (new defn)

Where someone can become a beneficiary, they are today. But, per (iii), must be a Canadian R related to settlor(?)

e.g.: Wife & kids can be taxed today

Where no power to add and have either 2 UK benefs or 2 Canadian benefs, should be okay

Despite the change in the law, can presumably still have a HK settlor & Canadian kids

Budget:

Any time that a Canadian R sets up a NR Trust, the trust will be deemed R

If Canadian settlor dies & benefs are HK kids, still caught

Changed so that any distribution of accumulated income from a NRT is taxable

HK R ( NRT ( Canadian benefs now caught

If started with 10M & accumulate 30M before it becomes R, the 30 will be taxed when it comes out

Cuts out the abuse but with ridiculous results. Will lead to non-respect of the law.

XII. Avoidance & Evasion

Golden case, SCC

Reallocation of proceeds of disposition not justified per s. 68 (reasonableness)?

purchase of land & building for $5M & 1M respectively to avoid recapture

Allowed by SCC: one TP avoids recapture but the other loses out

New developments since book put together: 3 new cases.

With application of GARR, the scene has completely changed

Older cases, like Stubart, is still good law but Rev. will increasingly rely on GARR (even if transaction is legally valid, its an abuse of the Act).

Evasion v. Avoidance

Evasion = Fraud

Concept of fraud is not universal; its meaning varies by jurisdiction.

In Switzerland, fraud does not arise solely from not reporting; need an intent to deceive.

In Canada, the more it looks legal, the more its perceived as non-fraudulent. Other countries would see multiple corporations & contracts as fraud.

Evasion is not defined in the Act but clearly provided for at s.239(1)239(1) - Anyone who wilfully deceives, conspires, omits, makes false entries is guilty of an offense

Redpath (141)

Offshore co in Bermuda; no staff or operations

Clearly established to take a cut of the raw material headed to Canada for processing, thus reducing the profitability of Canadian operations

Crown lost their case because, from a rule of law standpoint, there was no deception. There were contracts & everything was above board.

May have won if they pursued civilly but unable to meet the criminal BOP.

Myers (141)

TP lost because there was deception involved

2 offshore corps; TP was owner the two & ran a financial publication.

Claimed his only interest in the corps was his salary

Was diverting money

E.g. of avoidance - p. 141-42

$10M avoidance via a 99 year deferral

At 6%, present value of the 99 year deferral is $31,000

Rev. would argue that this is a sham

Financial lease

Tax-driven arrangements

e.g.: buy an aeroplane for $10M. Cant deduct more than the CCA. Therefore, will lease it from a third party for 15 years at an inflated amount, thus entitling TP to a deduction. After the 15 years, will buy it for $1, but it will still have a value of $5M

Will be held to be a sale, not a lease

A leading case on this: Lagure Construction (?)

Burden of proof (p. 142)

On the TP for civil matters

On Revenue for criminal matters (beyond a reasonable doubt)

Stubart

Stubart: No business purpose test. If a transaction follows the ITA & is technically correct, its legit. However, SCC also laid out a 3 step test to see if a transaction is outragous - if so, could be stopped.

Issue: Where there is no business purpose to a transaction, can you do a transaction to reduce tax burden?

SCC: There is no general business purpose test in the ITA.

But there are specific BPT in specific sections:

55(2) - Anti-avoidance provision re: C.G. stripping

Where a TP does X, where one of the purposes is to reduce C.G.

Butterfly exception: to allow tax-free transfer of assets via a change in form

94.1 - If you invest in an offshore investment fund, that is not a foreign affiliate, and a main purpose is to avoid taxes, will have to report income earned in on current basis

Has been quite ineffective; won 1 case in over 10 years.

Announce in Feb that it will be modified to remove a purpose test (caught automatically)

SCC: If the transaction is legally effective, / if the transaction is legally ineffective or a sham, dont need a BPT as it will fall on its own.

Specific BPT: must look at the actual provision.

If it is drafted with a specific test, clearly exists.

If drafted with the intent to restrict to target specific a group / transaction, will also find a BPT.

Will be decided on a case-by-case basis.

Stubart still good law but at the end of the day GARR much easier to use

Newman

TP should be allowed to structure his affairs

However, this is also another pre-GARR case

Shell (Kiwi)

Example of Stubart Needed $US but went about it by borrowing in a weak currency

Via a series of hedging transactions, avoided the risk

Appeal: In substance, you borrowed in $US, can only claim 9%, not 17% as the difference is merely a prepayment of capital.

Shell won at trial, lost on appeal, now before SCC.

Tax Planning v. Tax Avoidance (144)

Using provisions of the ITA to reduce taxes owing (RRSPs, losses to offset other income)

4th Problem - p. 157

Q: Client asked to pay kickbacks to foreign officials. Is it a deductible expense?

Were deductible, if for bona fides business purpose

Now: s. 67.5 - Non-deductibility of illegal payments If illegal in a foreign jurisdiction, can deduct

Questions:

1. Do you need a conviction in the other jurisdiction to be caught under it? Revenue says so but Mason disagrees; how could a Rev. official judge what will be held illegal in another country?

2. Public policy concerns: illegal activity

Specific anti-avoidance provisions are numerous

15 SH

18(4) Thin cap

69 FMV

Trans-national Anti-Avoidance - pp. 147-48

Profit diversion

Profit Extraction

Conferral of benefit on NRs

Emigration of corporation

GARR - s. 245

Introduced in the late 1980s

245(1) - Defns

245(2) - Charging provision

Where a transaction is an avoidance transaction, the tax consequences will be determined according to what is reasonable in the circumstances.

245(4) - Big carve-out

NA to a transaction where it may be regarded that there will not be a misuse or abuse of the Act, but for this section.

Only 3 cases decided - all won by the fiscus

1) McNicholl, Tax Ct

Bonner, J. - Jan 97

Partners in a law firm; had a mgmt co. that owned a building. P dissolved, building sold for a gain.

Management co. now had $316,000 cash to distribute

Rather than have a deemed dividend.. opt for LCGE:

Mr. X buys mgmt co. from partners, who are paid tax free, given the lifetime CP exemption

Mgmt co. wound up into Mr. Xs company.

Is this GARR-able?

Held:

At issue is only cash, no real business. Sole motivation is tax purposes, constituting a misuse & abuse of the Act.

Mason: may be different if still had the building.

2) Equilease

Bowman, J. - Apr. 97

Canadian subsidiary of a large group - to be wound up

Holdings: $3M + another $1.5 of value (tax refunds, etc.)

3rd party (also in the US) found to buy the shares of the company, who can claim treaty protection under the Canada-US Convention (no tax)

Held:

Dont need GARR.

1. This is a de facto winding-up of the corporation Fall under 84(2)

2. 212.1 applies - Anti-avoidance provision for dividend stripping: NAL parties trying to take advantage of a treaty for tax purposes.

Even if wrong on the above, GARR would apply anyway

3) Nadeau

Tardif, ~ Feb. 98

Manufacturing of PUC in a corporation by borrowing money to create a NewCo with higher PUC

Did this a few times

Lost in court

State of the law today

Tax planning still works - i.e.: reduce taxes in the course of carrying on a business, etc.

But, to fabricate a transaction solely to reduce taxes - likely to be caught

Lower courts have been very favourable towards the fisc; remains to be seen how the SCC will view GARR. Time will tell how GARR applies to various transactions under the Act.

Exam

Whole course / General policy, less facts

13