Canada’s 2019 Budget contained no specific response to U.S. tax reform and did not change the rate of corporate tax. However, it did include several tax measures with implications for businesses and multinational corporations in particular.
Canada’s Finance Minister, Bill Morneau, tabled the Liberal government’s fourth budget (the Budget) on March 19, 2019.
Changes of Particular Relevance to Multinational Corporations
Extension of Foreign Affiliate Dumping Rules
Generally, the foreign affiliate dumping rules may impose deemed dividends or suppress paid-up capital in circumstances where a corporation resident in Canada (CRIC) invests in a foreign affiliate and the CRIC is controlled by a nonresident corporation (or where a CRIC makes an investment in a foreign affiliate of a corporation that does not deal at arm’s length with the CRIC, if the CRIC or the non-arm’s length corporation is controlled by a nonresident corporation).
The Budget proposes to expand the application of the foreign affiliate dumping rules to include investments where the CRIC is controlled by a nonresident individual or trust or a group of persons that do not deal with each other at arm’s length, comprising any combination of nonresident corporations, non-resident individuals and nonresident trusts.
In order to make this change effective, the Budget also proposes an expanded definition of “related” that applies for the purpose of determining whether a nonresident trust does not deal at arm’s length with another nonresident person.
Transfer Pricing Measures
In situations where both the transfer pricing rules and other provisions of the Income Tax Act may apply, the Budget proposes an ordering rule to ensure that the transfer pricing rules are given priority. The current exceptions to the transfer pricing rules that apply where a controlled foreign affiliate owes an amount to a Canadian resident corporation, or a guarantee is made in respect of an amount owing by such affiliate, would continue to apply.
Second, the Budget proposes to expand the circumstances in which the Canadian tax authority can take advantage of an extended limitation period when reassessing as a consequence of a transaction involving a taxpayer and a nonresident with whom the taxpayer does not deal at arm’s length.
The Budget proposes to expand the definition of “transaction” to include an arrangement or an event. This change will make the circumstances in which the extended limitation period applies consistent with the definition of “transaction” in the transfer pricing rules, but will also increase the length of time during which taxpayers must be concerned about the possibility of a reassessment.
“Combating Aggressive International Tax Avoidance”
The Budget affirmed the Government of Canada’s continuing commitment to the Organization for Economic Co-operation and Development (OECD)/G-20’s Base Erosion and Profit Shifting (BEPS) project. The Budget states that Canada will continue “to work with its international partners to improve and update the international tax system, and to ensure a coherent and consistent response to fight cross-border tax avoidance.”
The Budget highlights two particular ways in which it has been participating in the BEPS project.
First, it points out that large multinational enterprises must file country-by-country reports that include information on their global allocation of income and taxes, as well as the nature of their global business activities. The Canada Revenue Agency (CRA) exchanges these reports with the tax authorities of other countries where the appropriate treaties are in place.
Second, the Budget highlights that Canada is one of 86 signatories to the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (the MLI). While the Budget states that the government is taking the necessary steps to ratify the MLI and bring it into force, it does not indicate when such ratification and coming-into-force can be expected to happen.
General Changes Relevant for Businesses
Cross-border Securities Lending Arrangements
Under the existing rules applicable to securities loans, an anomalous result can occur where a Canadian-resident borrower undertakes a “securities lending arrangement” with a nonresident lender.
In particular, where the borrower posts cash or government debt with a value of 95% or more of the loaned share throughout the term of the arrangement, dividend equivalent payments will be deemed to be dividends paid on a Canadian share, whether or not the loaned security is in fact a Canadian share. As a result, the dividend equivalent payments in respect of foreign shares lent to the Canadian resident borrower under such agreements are effectively treated as dividends paid on Canadian shares for withholding tax purposes. Budget 2019 proposes legislation to remedy this anomalous result in certain circumstances.
The Budget also expands the class of dividend-equivalent payments deemed to be Canadian source dividends to include those that are not 95% collateralized (provided they meet other tests to be deemed Canadian source dividends).
Finally, the Budget proposes to change the way in which payments made by Canadian borrowers under securities lending arrangements and specified securities lending arrangements are treated for treaty purposes.
Character Conversion Transactions
The Income Tax Act contains rules that treat gains or losses from the disposition of capital property purchased or disposed of under a “derivative forward agreement” as being on income account. However, there is a specific “commercial transaction” exemption that applies in certain circumstances.
In order to reduce certain kinds of tax planning involving this exemption, the Budget proposes to limit its application in circumstances where, in general terms, “it can reasonably be considered that one of the main purposes of the series of transactions, of which an agreement to purchase a security in the future (or an equivalent agreement) is part, is for a taxpayer to convert into a capital gain an amount paid on the security, by the issuer of the security, during the period that the security is subject to the agreement.”
Mutual Fund Trust Allocations
The Budget contains a proposal aimed at restricting the ability of mutual fund trusts to allocate fund capital gains to redeeming holders of units of such trusts. In particular, the Budget proposes to deny mutual fund trusts a deduction where capital gains are allocated to redeeming unit-holders in excess of the capital gains that would otherwise have been realized by these unit-holders on the redemption of their units. The Budget also proposes to deny mutual fund trusts from allocating ordinary income to redeeming unit-holders.
The Budget also contains the following proposals:
- Enhanced CCA for zero-emission vehicles: generally, the capital cost allowance (CCA) regime allows for annual deductions approximating the rate of depreciation of capital property. The Budget proposes to provide a temporary 100% CCA deduction in respect of certain zero-emission vehicles newly acquired for use in a business.
- Support for Canadian journalism: the Budget allows certain “qualified Canadian journalism organizations” to register as qualified donees for the purposes of receiving charitable deductions; creates a refundable labor tax credit that applies in certain circumstances to wages and salaries in respect of newsroom employees; and creates a new non-refundable personal tax credit for digital news subscriptions.
- Elimination of taxable income criteria in calculating Scientific Research and Experimental Development (SR&ED) for Canadian-controlled private corporations (CCPCs): The Budget proposes to eliminate the taxable income criteria in determining the expenditure limit for a CCPC for purposes of the 35% enhanced refundable tax credit for SR&ED activities.
Multinational corporations and other taxpayers should be aware of the changes in the Budget and seek tax advice about the impact of the changes discussed above.
In particular, the changes to the foreign affiliate dumping rules may result in undesirable tax consequences where a CRIC is held by a nonresident individual or trust and the new transfer pricing rules may affect enterprises’ susceptibility to transfer pricing readjustments.
Taxpayers should also be aware of the government of Canada’s continued commitment to the BEPS initiative, which suggests that further limitations on international tax planning opportunities may be yet to come.
Matias Milet is a Tax Partner and Roger Smith is a Tax Associate at Osler, Hoskin & Harcourt LLP in Canada
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