A number of legislative proposals were introduced this past year to clarify provisions contained in the Canadian Income Tax Act (the Tax Act), write Michael McLaren and Nicholas McIsaac of Thorsteinssons. Many of these may impact international tax planners with respect to investments in Canada.
In addition, two provinces have introduced taxes on foreign buyers of Canadian real estate in the Vancouver and Toronto areas. The courts have also provided clarity on a number of issues, including the disclosure of tax accrual working papers to the Canadian tax authority, and the availability of the judicial remedy of rectification in transactions resulting in unforeseen tax consequences.
The Tax Act recognises two forms of corporate control: de jure (legal) control and de facto (factual) control. The concept of de facto control is broader than de jure control and is meant to restrict what the government considers inappropriate access to tax preferences. For example, whether or not a Canadian corporation is a Canadian-controlled private corporation and has access to the preferential small business tax rate is based on whether or not one or more non-resident persons exercise de facto control of the corporation.
The 2017 Federal Budget expanded the definition of de facto corporate control in direct response to the Federal Court of Appeal's decision in McGillivray Restaurant Ltd. v. The Queen, 2016 FCA 99. In McGillivray, the court found that a factor can be considered in determining whether factual control exists, only if it includes "a legally enforceable right and ability to effect a change to the board of directors or its powers, or to exercise influence over the shareholder or shareholders who have that right and ability". Unhappy with this decision, Parliament sought to clarify the meaning of de facto control for the purposes of the Tax Act.
The proposed legislation provides that all factors that are relevant in the circumstances must be taken into consideration when determining whether a taxpayer has direct or indirect influence that could result in de facto control. The new definition of de facto control provides that this influence is not limited to, and that the relevant factors to be considered in determining its existence need not include, a legally enforceable right or ability held by the taxpayer to effect a change in the corporations' board of directors or the board's powers or any ability to exercise influence over the shareholder or shareholders who have such right or ability. As a result, the proposed amendment would effectively overrule the test set forth in McGillivray and broaden the circumstances under which de facto control may exist.
In July of 2016 British Columbia introduced a 15% property transfer tax on foreign purchases of residential property in the Greater Vancouver area. On April 20 2017, Ontario announced it would also impose a 15% non-resident speculation tax on foreign purchasers of residential property in the Greater Golden Horseshoe area of southern Ontario, encompassing Toronto, Hamilton and neighbouring areas. The two taxes were introduced as part of initiatives to make housing more affordable for residents of two of Canada's largest urban communities.
These new taxes are imposed on foreign entities or taxable trustees that purchase residential property in the prescribed areas. The types of property that qualify as residential property differ under the Ontario and British Columbia rules, but both are aimed at taxing dispositions of single-family residences, certain multi-family residences and condominiums. Exemptions are available in certain situations, including, for example, where the spouse of a non-resident entity is a resident of Canada for purposes of the Ontario tax, and rebates are available under other circumstances.
As part of a federal plan to stabilise Canada's housing market and ensure compliance, the Federal Government also introduced amendments to the principal resident exemption rules contained in the Tax Act. Paragraph 40(2)(b) of the Tax Act provides an exemption from capital gains on the disposition by an individual of a residential property that was at any time the individual's principal residence. The extent of the exemption is determined pursuant to a formula that factors in the number of years the individual designated the property as his or her principal residence while he or she was resident in Canada, plus one. This 'plus one rule' ensures that an individual who sold one property and purchased another in the same year can eliminate the full gain on both properties.
As of October 3 2016, the plus one rule no longer applies to individuals who were not resident in Canada at the time of the acquisition of the property. This change is meant to address non-residents who buy and sell property within the same year, using the plus one rule to exempt the entire gain from tax. In addition, restrictions have been placed on the types of trusts that may benefit from the principal residence exemption.
The Tax Act contains a number of provisions that, for various policy reasons, provide tax-deferred treatment on the transfer of property in certain instances. These provisions do not currently apply to situations where non-resident corporations owning taxable Canadian property, as the term is defined in the Tax Act, merge, and the property is transferred to a successor corporation.
In September 2016, Parliament introduced new provisions allowing taxpayers to elect for dispositions of taxable Canadian property that are shares of a Canadian-resident corporation to occur on a tax-deferred basis, where the disposition results from a foreign merger that meets certain conditions. The proposed provisions do not provide tax-deferred treatment of the disposition of other types of taxable Canadian property.
In order to qualify for the tax-deferred treatment, the merger must occur between two or more predecessor foreign corporations that were resident in the same country and related to each other prior to the merger. In addition, no shareholder of either predecessor foreign corporation may receive consideration other than shares of the new corporation, and the Canadian corporation whose shares represent taxable Canadian property to the non-resident must not have been subject to a loss restriction event in the 24-month period prior to the merger. If tax-deferred treatment is desired, the new corporation formed on the merger and the predecessor non-resident corporations must file a joint election in accordance with the prescribed rules.
Parliament also introduced provisions clarifying the tax consequences where shares are exchanged pursuant to a foreign spin-off. The proposed amendments to the Tax Act provide that where a non-resident corporation is divided under the laws of its jurisdiction and new shares are received by a shareholder on a pro rata basis, there is deemed to be a dividend paid to the shareholder rather than a taxable benefit. Conversely, if shares are not received on a pro rata basis, a shareholder is deemed to have received a taxable benefit from the non-resident corporation.
These amendments apply to foreign mergers and spin-offs that occur on or after the Announcement Date of September 16 2016.
Life insurance companies resident in Canada have historically enjoyed an exemption for their income from carrying on business in a foreign jurisdiction. While the foreign accrual property income (FAPI) rules did apply to controlled foreign affiliates with respect to the insurance of Canadian risks, there was no similar rule regarding foreign branches of Canadian life insurance companies.
The 2017 Federal Budget proposed to amend the Tax Act to ensure that Canadian life insurers would be taxable in Canada with respect to their income from the insurance of Canadian risks both through controlled foreign affiliates and foreign branches. The rules apply where 10% or more of the gross premium income (net of reinsurance ceded) earned by a foreign branch of a Canadian life insurer is premium income in respect of Canadian risks. Where the rule applies, it will deem the insurance of Canadian risks by a foreign branch of a Canadian life insurer to be part of a business carried on by the life insurer in Canada, and the related insurance policies to be life insurance policies in Canada. Anti-avoidance rules that were introduced to the FAPI regime in the 2014 and 2015 Budgets will be extended to foreign branches of life insurers and new anti-avoidance rules dealing with a transaction or series of transactions, one of the purposes of which was to avoid the existing rules, will be introduced to reinforce the existing anti-avoidance rules in the FAPI regime.
On July 18 2017, the Federal Government of Canada introduced proposed legislation dealing with what they describe as a variety of tax loopholes achieved through the use of private corporations. While these proposals are currently still in the consultative phase, their application is far-reaching and has the potential to impact a wide array of taxpayers.
Proposed section 246.1, for example, is an anti-avoidance rule aimed at "surplus stripping" whereby corporate surplus is distributed to Canadian shareholders on a tax-free or tax-reduced basis in a non-arm's-length context. While this provision would generally not apply to non-resident shareholders of Canadian private corporations, proposed subsection 246.1(3) will reduce the capital dividend account (CDA) of the corporation to nil where such a distribution is made and it "can reasonably be considered that one of the purposes of the transaction, event or series was to effect a significant reduction or disappearance of assets of a private corporation", such that tax is avoided.
The Consultation Paper on the proposed legislation also addresses the taxation of passive investment vehicles. While no specific legislation is proposed and the consultative process remains open, some of the concerns addressed include the taxation of passive income in non-Canadian controlled private corporations and the use of complex cross-border corporate structures to defer taxes. As such, the forthcoming legislation may have an impact on non-residents investing in such vehicles.
On June 7 2017, Canada signed the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (MLI). It is one of sixty-eight jurisdictions that have signed the agreement, which is designed to efficiently implement certain BEPS measures without the need to amend treaties already in place.
Not all countries have adopted all the measures contained in the MLI. Canada has registered several reservations, but has adopted provisions setting out BEPS minimum standards for treaty abuse prevention and dispute resolution procedures, including an opt into the mandatory binding arbitration provisions. Measures from the MLI only modify existing treaties where both parties to the treaty have signed the MLI and neither party has registered a reservation with respect to a particular provision.
Canada has accepted the MLI measure on the BEPS minimum standard for treaty abuse provision. This provision essentially modifies the preambles of applicable treaties to state that in addition to preventing double taxation, the agreements are not intended to create opportunities for non-taxation or reduced taxation through tax evasion or avoidance. The MLI also sets out optional substantive rules providing a mechanism for determining treaty abuse. Canada, in signing the MLI, adopted the principal purpose test to determine whether or not a tax treaty has been abused. Canada did not adopt the limitations on benefits test contained in the MLI, although the provisions do appear in a variety of forms in certain Canadian bilateral agreements, including, for example, those entered into with the US and Hong Kong.
In World Tax 2017, we noted that Canada and Taiwan had entered into an income tax convention but that convention was not yet in force. This convention came into force on December 15 2016, the same date as the coming into force of the convention between Canada and Israel, which was signed on September 21 2016.
On November 24 2016, Canada also entered into an income tax convention with Madagascar. This convention is not yet in force.
On February 8 2017, the Agreement Concerning the Application of the Arbitration Provisions of the Convention between the Government of Canada and the Government of the United Kingdom of Great Britain and Northern Ireland for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with respect to Taxes on Income and Capital Gains was entered into force. The agreement modifies the current convention between Canada and the UK to implement mandatory binding arbitration.
On June 7 2017, Canada and the US entered into an arrangement to exchange country-by-country reports. These reports will outline the global allocation of income, taxes paid, and other information regarding multinational enterprises. This arrangement complements the Multilateral Competent Authority Agreement on the Exchange of Country-by-Country Reports, signed by Canada on November 5 2016 and entered into by 64 countries. The US is not a signatory.
This past year, the Canadian courts have addressed the disclosure of documents to the tax authority under a variety of circumstances. For example, in The Minister of National Revenue v Iggillis, 2016 FCA 1352, the Federal Court of Canada examined what is referred to as common interest privilege in the context of a commercial transaction.
Solicitor-client privilege protects communications between a lawyer and a client where such communication is made for the purposes of giving or seeking legal advice and is intended by the client to be confidential. This privilege may be waived where the client shares these communications with a third party, in which case the communications are no longer protected. The doctrine of common interest privilege, while not a separate type of privilege itself, was, before Iggillis, often recognised by Canadian courts as an exception to this waiver where privileged communications were shared with unaffiliated parties with the common interest of completing a transaction.
However, in Iggillis, the Federal Court departed from precedent in finding that a legal memorandum addressing the tax consequences arising from a series of commercial transactions, prepared by counsel of a party with whom the taxpayer had dealings, was not protected by solicitor-client privilege. The memorandum had been shared with the taxpayer as it was necessary for both parties to understand the structuring discussed therein to complete a deal. The court found that to apply the doctrine of solicitor-client privilege to communications in the allied lawyer setting, such as the sharing of the memorandum in question, was to protect communications that were not solely between a lawyer and client. While not explicitly stating that the sharing of the memorandum represented a waiver of solicitor-client privilege, the court found that the doctrine of solicitor-client privilege should not apply to communications received by the taxpayer that represented communications between the other party to the transaction and its own lawyer.
The 2015 Federal Court decision in BP Canada Energy Co v The Minister of National Revenue, 2017 FCA 61, resulted in much concern in the tax community. When granting the tax authority access to the taxpayer's list of uncertain tax positions, prepared as part of the taxpayer's tax accrual working papers, the court cited fairness as grounds for the access. However, the Federal Court of Appeal overturned the compliance order, establishing an important limitation on the tax authority's information gathering powers.
While the Federal Court of Appeal noted that subsection 231.1(1) of the Tax Act provides the Canadian tax authority with broad information gathering powers, it found that restraint should be used with respect to tax accrual working papers, in accordance with the intent of the provision. The court found that to decide otherwise would result in self-auditing by the taxpayer and would likely result in a chill on the preparation of useful documents for fear of disclosure to the tax authorities. While the tax authority may still request access to such documents in certain circumstances, the BP Canada case limits unrestricted access to tax accrual working papers.
In World Tax 2017 we discussed the Supreme Court of Canada decisions in Canada (Attorney General) v. Chambre des Notaires du Quebec, 2016 SCC 20, and Canada (National Revenue) v. Thompson, 2016 SCC 21, as they related to solicitor-client privilege. The Supreme Court of Canada found that lawyers and notaries should be excluded from the requirement regime contained in the Tax Act. In Revcon Oil Constructors Inc v The Minister of National Revenue, 2017 FCA 22, a taxpayer argued that its documents were subject to solicitor-client privilege and that a Federal Court order to disclose such information was an indirect order for the taxpayer's law firm to disclose information in contravention of the two Supreme Court decisions.
When dismissing the taxpayer's appeal, the Federal Court of Appeal found that the order was directed only against the taxpayer, requiring it to disclose all documents in its power, possession or control, and was not in contravention of the Supreme Court cases. The taxpayer could still argue that certain documents were in fact privileged, but the requirement regime in the Tax Act was still applicable to persons other than lawyers and notaries.
Historically, rectification has been a useful tool in revising transactions to account for unforeseen tax consequences. However, in the past year, two Supreme Court of Canada cases have significantly curbed a taxpayer's ability to use rectification as a means to achieve such objectives. In the cases of Jean Coutu Group (PJC) Inc. v Canada (Attorney General), 2016 SCC 55, and Canada (Attorney General) v. Fairmont Hotels Inc., 2016 SCC 56, the Supreme Court of Canada refused rectification orders in instances where the taxpayers had simply a general intention to avoid or minimise tax. While the former decision dealt with the civil remedy of rectification in the province of Quebec and the latter with the common-law remedy available in Ontario courts, the results in each were similar.
In both instances the parties sought to rectify documents related to transactions that produced unanticipated tax consequences. In Jean Coutu, the taxpayer wished to rectify written documents that resulted in the creation of FAPI. In denying the application, the court concluded that when unintended tax consequences arise from a contract, rectification will be available only if: (1) such consequences were originally and specifically sought to be avoided through sufficiently precise transactions, and (2) the transactions, if they had been properly executed, would have had the intended effect. The court found that the criteria were not met in this instance as the transactions contemplated by the parties were implemented as planned and there was no intent to avoid FAPI in their execution.
In Fairmont, the taxpayer sought to change a share redemption that triggered a foreign exchange gain to a loan, resulting in tax neutrality of the series of transactions implemented. The court again denied granting rectification finding that such an order requires more than a general intention to pursue a transaction in a tax-neutral manner. The court held that in order to grant rectification, the taxpayer must be able to point to a specific intention expressed in definite and ascertainable terms to achieve the results for which rectification was being sought, for example a prior agreement that was incorrectly recorded in the actual legal instrument.
Further to these cases, the Federal Court of Appeal in Canadian Forest Navigation Co. v The Queen, 2017 FCA 39, found that foreign rectification orders were not necessarily dispositive or binding on a Canadian tax assessment, but must be taken as facts at trial even in the absence of domestic recognition through homologation. As such, any analysis at trial to decide whether a taxpayer's foreign rectification orders would be sufficient to avoid Canadian income tax consequences would still need to meet the requirements set forth in Jean Coutu and Fairmont.
In Rio Tinto Alcan Inc. v The Queen, 2016 TCC 172, the Tax Court of Canada made a major change to the deductibility of investment banking fees paid for services rendered to assist board members in deciding whether to approve proposed transactions. Historically fees such as these were considered by the tax authority to be capital in nature and were not deductible in the year incurred, instead being added to the adjusted cost base of the acquired property.
The taxpayer in this instance deducted professional advisory fees incurred in regards to a share acquisition of an aluminum producer, and a subsequent spin-off of certain assets, from its income as current expenses for the taxation year. After being reassessed by the tax authority, the taxpayer appealed, arguing that the expenses were incurred as part of its ordinary business operations and were properly deductible as current expenses under the Tax Act. Partially allowing the appeal, the Tax Court of Canada drew a distinction between "oversight expenses", related to professional services rendered to the board in the oversight and decision-making process, and "execution costs", related to the actual implementation of the approved transactions. The court found that the former, which were incurred up until the point where the transactions were approved and committed to, were deductible as current expenses as they allowed the board to properly exercise its oversight function. The latter remained capital expenses and were added to the adjusted cost base of the acquired property.
The Canadian courts released two cases this past year dealing with the mutual agreement procedure (MAP). In CGI Holding LLC v The Minister of National Revenue, 2016 FC 1086, the Federal Court found that the conduct of the Minister of National Revenue (Minister) in the context of MAP negotiations between the Canada Revenue Agency (CRA) and the Internal Revenue Service (IRS) that resulted in no agreement between the two competent authorities was reviewable by the Federal Court. While finding that the Minister's conduct was reasonable in the circumstances, thereby granting no remedy to the taxpayer, this decision opens the door for judicial review of MAP outcomes. However, given the level of deference the court showed to the Minister in reaching its decision, whether such an application will be worthwhile is questionable.
In Sifto Canada v The Queen, 2017 TCC 37, the Tax Court of Canada found that agreements between the CRA and IRS, concluded pursuant to MAP negotiations, were binding on the Minister. The taxpayer had originally understated its income with regards to the sale of rock salt to a related US company for certain taxation years. After disclosing these errors to the Canadian tax authority through the voluntary disclosure program, the taxpayer was reassessed on its income, resulting in double taxation in Canada and the US. The taxpayer and its US affiliate made applications to their respective competent authorities and an agreement was reached through MAP negotiations. The Canadian tax authority subsequently audited the taxpayer and increased its income for the years in question.
In allowing the taxpayer's appeal, the Tax Court of Canada found that the Canadian tax authority was bound by its agreements with the taxpayer and the US competent authority. Since the reassessments were inconsistent with these agreements, they were referred back to the tax authority for reconsideration based on the fact that the tax authority could not vary the rock salt income from those amounts determined in the agreements.
In the section 'Statutory developments' above, we discussed the 2017 Federal Budget proposal to amend the definition of de facto control. However, before the 2017 Budget, the Tax Court of Canada was forced to provide clarification of the test for de facto control based on the current provision and the common-law in reaching its decision in the case of Aeronautic Development Corporation v The Queen, 2017 DTC 1019.
In deciding whether a non-resident individual and/or non-resident corporation had direct or indirect control of the taxpayer for the purposes of determining its status as a Canadian-controlled private corporation, the court used the narrow test for de facto control set out in McGillivray. In this instance the taxpayer was partially owned by Seawind, a US-resident corporation that held 46% of the voting shares of the taxpayer. Seawind was in turn controlled by a US-resident individual.
In finding that the taxpayer was controlled in fact by Seawind and/or its non-resident shareholder, the court placed a heavy emphasis on a development agreement between the taxpayer and Seawind, which was the taxpayer's only client. The court found that the US resident individual who controlled Seawind had the ability to affect the economic interest of the voting shareholders in a manner consistent with de facto control of the taxpayer. As a result, the taxpayer was not a Canadian-controlled private corporation for purposes of the Tax Act. Given that the stricter test for de facto control set forth in McGillivray was met in this instance, circumstances such as those present in this case would also likely represent de facto control under the proposed definition.