International Tax Newsletter - Winter 2011-12 - Canada
March 01, 2012
INBOUND INVESTMENT TO CANADA
U.S. businesses need to structure new and ongoing ventures in Canada in the wake of the Fifth Protocol to the Canada-U.S. Tax Treaty signed in 2007. An unlimited liability company (ULC) can be incorporated in the provinces of Nova Scotia, Alberta and British Columbia and is generally treated as a fiscally transparent entity for U.S. tax purposes but taxed as a corporation under Canadian rules. New Article IV(7)(b) under the Protocol generally eliminates the treaty benefit to a U.S. resident member of a ULC on a cross-border payment from Canada by deeming the member not to be a U.S. resident for treaty purposes (and thereby eliminating treaty benefits) under the foregoing structure. For a dividend to U.S. members, loss of the treaty benefit could imply as much as 25% versus 5% Canadian withholding tax rate. Solutions may include:
- Inserting an intervening foreign entity (such as a Dutch Co-op or a Luxembourg SARL between Canada and the U.S. member)
- Increasing the paid-up capital for Canadian tax purposes that will result in a deemed dividend for Canadian tax purposes followed by a return of capital distribution to the U.S. member – this will generally result in the availability of the applicable treaty-reduced rate, 5% in the case of qualifying corporations.
In addition, the CRA will generally look through a partnership (rather than LLC) to give treaty benefits to its members, so a member of a U.S. partnership will still be able to obtain treaty-based rates on a capital increase strategy.
OUTBOUND INVESTMENT FROM CANADA
On August 2011, Canada’s Finance Minister introduced a long-awaited package of proposed amendments to Canada’s foreign affiliate rules, Canada’s tax regime for foreign subsidiaries and significant investees of Canadian multinational corporations, referred to as the foreign affiliate rules. Given the Government’s majority in the House of Commons, it is expected that this package may be passed into law within the next few months.
The proposals contain the following components:
- Hybrid surplus — a new surplus account to capture gains from the sale of foreign affiliate shares
- Upstream loans – a rule to protect the integrity of the hybrid and taxable surplus regimes by discouraging transactions designed to avoid taxation of taxable dividends through the use of loans from foreign affiliates to their Canadian shareholders
- Reorganisations — rules to:
- Allow more generous foreign accrual property income (FAPI) rollover treatment of asset dispositions by a foreign affiliate in the context of mergers and liquidations by, for example, allowing all types of property, not just capital property, to qualify for rollover treatment; and
- Prevent the duplication of losses on certain share-for-share transactions
- Return of capital – rules to allow more generous and simplified treatment of distributions from the capital of a foreign affiliate by allowing taxpayers to elect to have the full amount of their cost of the shares be returned before any distributions become taxable
- Surplus reclassification — a rule to reclassify certain gains from business asset sales from exempt to taxable surplus in situations where a taxpayer forces the disposition of such an asset for the primary purpose of creating exempt surplus
- Stop-loss rules — amendments to:
- Provide relief from loss denial rules that apply on the disposition of shares of a foreign affiliate by allowing a portion of such a loss to the extent the taxpayer realizes a foreign exchange gain on a related financial instrument
- Ensure that certain loss denial rules do not apply in the computation of foreign affiliate surplus balances and apply properly in the context of foreign accrual property losses
- FAPI capital losses – new rules to align the FAPI system with domestic rules by providing that capital losses can only be deducted against capital gains.
More information on these developments can be provided by Bill Macaulay, Tax Partner, Smythe Ratcliffe LLP, Chartered Accountants, through the EisnerAmper contacts listed on the homepage.
International Tax Newsletter - Winter 2011-12 Issue