canada Archives -

Tax Law – Patrick Westaway

 

View the chart here:

Canadian and Ontario Film and Television Tax Credits (Chart)

 

Patrick is a corporate/commercial and tax lawyer of more than 16 years’ experience. He regularly advises in such technology industries as animated feature film production, online gaming and telecommunications with an emphasis upon cross-border enterprise and investment structuring.

Tax Law – Patrick Westaway

It is critical for non-residents to obtain proper Canadian legal advice respecting their long-term tax position before entering the Canadian market. The tax consequences of the various available structures vary significantly and opportunities for tax savings can be considerable.

The tax issues arising upon entering the Canadian market are best understood by recognizing that there are only three basic vehicles. A non-resident corporation may carry on business in Canada directly, through a Canadian corporation or through a partnership involving either or both of the foregoing. Once the consequences of each alternative are understood and compared, more complex, contextual, structures may be tailored from these basic building blocks.

Admittedly, this is a simplistic analysis since only the basic ‘building blocks’ are considered. Furthermore, this analysis is limited to the Canadian side of the equation. In respect of the first limitation, the essential point is that the tax issues remain the same for the most complex as for the simplest structures. The simpler the structure, the more readily understood are the tax issues. As to the second limitation, it is, of course, necessary to always consider the tax issues in the applicable foreign jurisdiction.

I. Permanent Establishments

Focusing, then, upon the Canadian side of the equation, the first scenario is one in which the non-resident corporation would carry on business in Canada directly. From a domestic perspective, subsection 2(3) of the Income Tax Act (Canada) (the “Tax Act”) would subject the non-resident to Canadian income tax on all Canadian-source business income. From a cross-border perspective, however, there may be an opportunity to avoid Canadian taxation by avoiding a Canadian permanent establishment. The first point to consider, then, is the threshold at which the Canada Revenue Agency (the “CRA”) would determine a permanent establishment to arise for the purposes of Canada’s typical tax treaty.

It should be noted at the outset that treaty exemptions for non-residents carrying on business in Canada without a permanent establishment usually apply only to non-residents that are corporations. A similar exemption involving the identical concept of “fixed base” applies to individuals. That the concepts of “permanent establishment” and “fixed base” are identical has been recognized by the recent deletion of the latter concept from the Canada-U.S. Tax Convention (1980) (the “Canada-U.S. Treaty”) and the expansion of the former to benefit individuals. All comments on permanent establishments therefore apply equally to fixed bases.

(a) Permanent Establishment

The definition of a “permanent establishment” is set out with some particularity in the tax treaties. In essence, these definitions provide that a permanent establishment is predicated upon any of: (i) a place; (ii) a person; or, in the case of the U.S. treaty, (iii) time allocation.

(i) Places

A permanent establishment as a place requires a “fixed place of business”; that is, a physical location controlled by, and identifiable by prospective clients with, the non-resident. Aside from the obvious examples of owning or leasing space, a non-resident may simply be permitted to use the office of a Canadian affiliate or client. In such circumstances, we would need to consider whether the non-resident has a key to those premises and access at any hour, whether it uses those premises to service other clients and whether it hangs its own shingle in the lobby or hands out business cards with that address or phone number. Relevant factors are as varied as the circumstances.

(ii) Persons

The second concept is that of a permanent establishment as a person. A person can be a permanent establishment if it has and habitually exercises in Canada the authority to contract on behalf of the non-resident. If circumstances permit, this situation can be avoided simply by denying any person in Canada the authority to execute contracts on the non-resident’s behalf.

If, for example, a non-resident is to have only a sales force in Canada, a permanent establishment could be avoided by requiring head-office approval for all sales contracts. In this scenario, it should be noted that the typical treaty definition of “permanent establishment” specifically excludes the use of facilities for the purpose of storage, display or delivery of merchandise. A Canadian sales and distribution network could, therefore, be organized to avoid Canadian income tax entirely—subject to the new 183-day rule.

(iii) Time Allocation: The New 183-Day Rule

A third branch of the definition of permanent establishment is exclusive to Canada’s tax treaty with the U.S., applicable as of January 1, 2010. This branch applies in either of two sets of circumstances:

(A) services are provided in Canada by an individual who is present in Canada for an aggregate of 183 days or more in any 12-month period and more than 50% of the non-resident’s gross active business revenues derives from those services; or

(B) services are provided in Canada by any number of persons, whether or not individuals, for an aggregate of 183 days or more in any 12-month period and those services are in respect of the same or a connected project—in this case, the customers may be either residents of Canada or merely have permanent establishments in Canada, provided in the latter case that the services are provided in respect of those permanent establishments.

The first scenario, which contemplates only a single individual, applies to any number of projects whereas the second scenario, which contemplates any number of persons, applies only to a single or a connected project. Further, whereas the first scenario applies a revenue test, the second does not. When considering the use of local representatives, it should also be noted that the typical treaty specifically excludes from the definition of “permanent establishment” any agent of an independent status acting in the ordinary course of its business. Thus, distributors and other independent contractors would not usually constitute a permanent establishment.

(b) Pros and Cons

Assuming that the non-resident chooses to carry on business in Canada directly through a permanent establishment, what are the consequences? First, that non-resident would be subject to Canadian income tax on all net Canadian-source income attributable to the permanent establishment. Although a foreign tax credit would presumably be claimed in the non-resident’s home jurisdiction, the non-resident would remain liable to pay the higher of the two tax rates and would be required to file a Canadian income tax return. Second, liabilities incurred in Canada would be incurred by the non-resident—there would be no limitation of liability otherwise afforded by a subsidiary corporation. Third, customers of the permanent establishment would be required to withhold and remit income tax on all payments that they make to the permanent establishment, although non-resident corporations typically obtain waivers for this withholding and remittance requirement.

On the other hand, the principal benefit of carrying on business through a permanent establishment is that any losses incurred in Canada would generally be deductible by the non-resident in its home jurisdiction against its non-Canadian-source income. A permanent establishment may also be preferable if the extent or frequency of business activity in Canada does not warrant the incorporation of a separate company.

(c) Branch Tax

The last issue when considering whether to carry on business in Canada directly is “branch tax”. Just as Part XIII of the Tax Act imposes a non-resident tax of 25% on dividends, so Part XIV imposes a branch tax of 25% on the after-tax profits of the branch that are not reinvested in the Canadian business. And, just as the tax on dividends is subject to reduction by treaty, so also is branch tax. This reflects the policy behind branch tax, which is to render tax neutral the choice between a branch and a subsidiary. Differences arise, however, in that the treaty-reduced rate applicable to dividends under most of Canada’s tax treaties is variously 5% or 10%, as discussed in Part II(b), below, whereas the treaty-reduced rate applicable to branch tax is 5%.

Further differences between branch tax and non-resident tax are as follows. First, there is a timing difference since branch tax is payable annually whereas the non-resident tax applicable to dividends is payable when the dividend is paid or credited. Second, Canada’s tax treaties typically provide a one-time branch tax exemption on the first $500,000 of net income. No such exemption applies to dividends, although an analogous result may be obtained for dividends through the use of an acquisition company, discussed in Part II(c), below.

II. Subsidiaries

Thus far, we have reviewed the possibility of avoiding Canadian income tax by avoiding a Canadian permanent establishment and the tax consequences of carrying on a business in Canada through a permanent establishment. The next likely vehicle through which to carry on business in Canada is a Canadian subsidiary.

(a) Pros and Cons

The pros and cons of a subsidiary are the converse to those of a permanent establishment. As a separate legal entity, any losses generated by a subsidiary cannot be deducted by the parent. On the other hand, the subsidiary’s liabilities are its own and, as a Canadian corporation, its customers are not required to withhold and remit taxes. It should also be noted that a subsidiary’s tax filing obligations are also its own, which is significant if the non-resident does not wish to disclose its financial information to the CRA.

Prior to recent amendments to the Canada-U.S. Treaty, unlimited liability companies (ULCs) were often incorporated under the laws of Nova Scotia, Alberta or British Columbia to provide U.S.-resident investors with the benefits of both a permanent establishment and a subsidiary. However, as a result of those amendments, all dividends, royalties and similar payments made to the U.S.-resident parent are now subject to non-resident tax, discussed below in Part II(b), at the full rate of 25% without the benefit of a treaty reduction or exemption. Nevertheless, ULCs continue to offer benefits for U.S. tax purposes, which must be weighed against the loss of treaty benefits. The continued benefits of these corporations is discussed in a separate article.

Notwithstanding that a subsidiary is an independent legal entity, care must be taken to ensure that the subsidiary cannot be construed to be a mere agent of its non-resident parent. In such a case, the CRA might consider the subsidiary’s premises to constitute a “fixed place of business” through which the non-resident parent carries on business in Canada, i.e., the subsidiary’s premises could be construed to be a permanent establishment. This result may be avoided when drafting inter-corporate services agreements by making it clear that the subsidiary is engaged in its own business, that the relationship between the non-resident and its Canadian subsidiary is one of customer and independent contractor.

(b) Non-Resident Tax and Income Tax

(i) Non-Resident Tax

If we divide the non-resident and the Canadian operation into separate legal entities, we must then consider taxes on all payments flowing between them. Part XIII of the Tax Act imposes a non-resident tax on various passive forms of income, including dividends, interest, rents, royalties and so forth. This 25% rate rarely applies, however, since Canada’s tax treaties generally reduce or eliminate this tax. Unlike the Tax Act, the tax treaties treat the various kinds of income differently such that each income source must be separately considered

Looking at dividends, the treaty-reduced rate under the typical treaty is 5% if the beneficial owner of the dividends is a corporation that owns at least 10% of the voting shares. In all other cases, the treaty-reduced rate for dividends is 15%. Rents on real property situated in Canada enjoy no tax reduction. Any amounts that could be allocated to royalties for software licences would enjoy a complete tax exemption under the Canada-U.S. Treaty while certain other royalties would be taxable at 10%.

Interest payments between arm’s-length parties are not taxable provided that the interest is not ‘participating debt interest’. This concept refers to debt on which interest is contingent upon the use of, or production from, property in Canada or that is computed by reference to revenue, profit, cash flow, commodity price, etc. or by reference to dividends paid or payable on the shares of a corporation (not necessarily the debtor corporation). In other words, participating debt is debt the interest on which could be characterized as disguised dividends. Given this exemption from non-resident tax on arm’s length interest payments, there is no tax disincentive to sourcing project financing abroad. When, however, debtor and creditor do not deal at arm’s length, we must rely upon a tax treaty for a reduction or exemption of the non-resident tax which would otherwise apply at a rate of 25%. Pursuant to recent amendments to the Canada-U.S. Treaty, interest payments between the two countries are wholly exempt from taxation in the source country. Under Canada’s other tax treaties, the typical rate is 10%.

(ii) Income Tax

Whereas Part XIII tax applies to passive forms of income earned in Canada by non-residents, income from carrying on business in Canada is subject to income tax under Part I of the Tax Act. It may be, for example, that the non-resident parent, or, perhaps, another member of the corporate group, will provide services to the Canadian subsidiary. In such a situation, income tax must be withheld by the Canadian subsidiary on all fees for such services at a rate of 15%. (For the application of sales tax to non-residents, see the article, Canada’s Federal Sales Tax—An Overview for Non-Resident Suppliers).

It should be noted that, whereas non-residents are not required to file Canadian tax returns in respect of non-resident tax, they are required to file Canadian tax returns in respect of income tax. As well, whereas a treaty reduction or exemption will reduce or avoid the amount of non-resident tax to be withheld, the same is not true of income tax. Income tax must be withheld at a rate of 15% regardless of the application of any tax treaty—subject only to the non-resident obtaining a waiver from the CRA. The treaty benefit is claimed, and the rebate obtained, when the tax return is filed.

(c) Acquisition Companies

The next point to consider in respect of the use of a subsidiary is the potential benefit of an acquisition company for the purchase of either Canadian assets or shares. In the absence of an acquisition company, the purchase price would simply be paid by the non-resident to the vendor and no tax benefit would be obtained by the purchaser (aside from a step-up in the cost base of the acquired shares or assets). If, however, the non-resident purchaser were to pay the amount of the purchase price to a Canadian subsidiary (which would then pay the vendor) paid-up capital would be created in the subsidiary (and the subsidiary would still obtain a step-up in the cost base of the acquired shares or assets). Thereafter, any distributions made by the subsidiary to the parent could, to the extent of the increased paid-up capital, be characterized as a tax-free distribution of capital rather than a taxable dividend or interest payment. Assuming the treaty-reduced rate under the Canada-U.S. Treaty of 5% on dividends, the tax savings to the non-resident on every $1 million of purchase price paid would be $50,000.

(d) Thin-Capitalization

Given the full tax exemption for interest payments under the Canada-U.S. Treaty, it is tempting to characterize all investment in a Canadian subsidiary by a U.S.-resident parent as debt. Unfortunately, there is already in place a “thin capitalization rule” which denies a deduction to the subsidiary for interest paid to the parent (or any other “specified non-resident”) if the debt owed to the parent (or other “specified non-resident”) exceeds 1.5 times its equity. Briefly, a “specified non-resident” is a non-resident that does not deal at arm’s length with the subsidiary or that, either alone or together with other non-arm’s-length persons, owns 25% or more of the subsidiary’s votes or value. Given the ability of the Canadian subsidiary to deduct interest payments (and not dividends), it is difficult to envision a scenario in which a U.S.-resident parent would not wish to maintain the maximum 1.5:1 debt to equity ratio. Pursuant to recent changes to the thin-cap rule, the amount of any denied interest deduction is re-characterized as a dividend payable to the non-resident. This gives rise to Part XIII withholding obligation, described above, and a tax cost to the Canadian borrower if it fails to withhold and remit that tax. The thin-capitalization rule is discussed in more detail in an article entitled, The New Thin-Cap: Lenders Beware.

(e) Transfer Pricing

Finally, the last issue of which we need to be aware in respect of subsidiaries is the potential application of the transfer pricing rules. Since a subsidiary is not a permanent establishment, the non-resident would not be subject to Canadian income tax on fees for services performed in Canada (although withholding and filing obligations discussed above would still apply). Consequently, a non-resident parent could extract profits from a Canadian subsidiary on a tax-free basis by characterizing such amounts as fees for services. Such payments would then be deductible by the Canadian subsidiary. The same result could be obtained through the sale of goods to a subsidiary. In order to prevent such abuses, the CRA applies transfer pricing rules to amounts charged for goods or services passing between Canadian corporations and non-arm’s-length non-residents. If the amounts charged differ from the amounts that would be charged between arm’s-length parties, as determined by the CRA, subsection 247(2) of the Tax Act authorizes the CRA to adjust the taxable income of the subsidiary accordingly. While the application of these rules is beyond the scope of this paper, taxpayers should be aware that these rules exist and that taxpayers are required to maintain contemporaneous documentation to identify and support all amounts paid to or received from related non-residents as consideration for goods or services.

III. Limited Partnerships

The third and final vehicle to be discussed on the Canadian side of the border is the limited partnership. The fundamental point is that the taxation of partnerships reflects the fact that they are not legal entities. While tax practitioners often speak somewhat loosely of partnerships as though they were independent entities, it is important to remember that they exist only as contractual relationships among the partners. This is true of limited partnerships as well as general partnerships notwithstanding that limited partners enjoy limited liability. Broadly speaking, then, if a non-resident were to organize its Canadian operations as a partnership, we would need to look through the partnership and consider all of the above issues in respect of each partner, which will either be carrying on business through a permanent establishment or Canadian subsidiary. Since a Canadian subsidiary is a Canadian resident, the following references to non-resident partners refer only to those non-residents that hold their partnership interests directly.

For the purposes of calculating income and losses of the partners, income is determined and expenses deducted at the partnership level and the resulting taxable income or losses allocated among the partners in accordance with the terms of the partnership agreement. In most instances, the partnership is then required to file an information return which the CRA can then cross reference with the income tax returns of each partner. This ability of limited partnerships to flow through losses to the partners while limiting liability is the reason such partnerships are often used as investment vehicles.

Partnerships with a non-resident partner are subject to specific rules relating to: (i) non-resident tax on payments to the partnership; and, (ii) income tax applicable to capital gains realized upon the disposition of taxable Canadian property held by the partnership.

(a) Non-Resident Tax

Paragraph 212(13.1)(b) of the Tax Act deems any amount paid or credited by a person resident in Canada to a partnership other than a “Canadian partnership” to be paid to a non-resident person. “Canadian Partnership” is defined in subsection 102(1) of the Tax Act to mean a partnership all of the members of which are resident in Canada. This relieves the CRA of the administrative burden of determining the residence status of each partner and the portion of each payment allocable to any non-resident partners. Instead, if even just one partner is a non-resident, Canadian-resident payors must withhold non-resident tax on dividends, interest, rents, royalties, management fees, and so forth paid or credited to the partnership.

Left on its own, the effect of this rule would be draconian given that non-resident tax is not a withholding tax per se but is a tax in and of itself and is therefore non-refundable. We therefore have a further rule according to which a partnership is to be ignored for the purpose of applying the tax treaties. In conjunction with paragraph 212(13.1)(b), this shifts the burden of determining the residence of each partner and its share of partnership income from the CRA to the taxpayers. If tax treaty benefits are to be claimed, the residence of each partner must be separately determined as of the time of each payment and the tax reduction or exemption under the relevant tax treaty must be separately applied to each partner.

If a U.S.-resident corporation owns shares through a Canadian partnership then, for the purpose of determining whether the lower of two treaty-reduced rates referred to in Part (II)(b), above, is available in respect of dividends, the U.S.-resident partner will be considered to own shares in proportion to its partnership interest. Before recent amendments to the Tax Treaty, the lower rate was never available when a partnership was interposed.

(b) Income Tax

If Canadian operations are to be structured as a partnership, it is important to consider that the permanent establishment of one non-resident partner is considered to be the permanent establishment of every non-resident partner. This rule applies to both general and limited partners. Every non-resident partner will, therefore, be subject to Canadian income tax on its share of the partnership income as though that partner were carrying on business in Canada directly through a permanent establishment.

(c) Tax Clearance Certificates

For the purpose of determining whether a tax clearance certificate is required under section 116 of the Tax Act in respect of the disposition of taxable Canadian property, the partnership is generally ignored. Only non-resident partners are required to obtain tax clearance certificates while Canadian-resident partners may rely upon their own Canadian resident status.

The difficulty arises in that a purchaser of taxable Canadian property is liable to pay tax in an amount equal to 25% of the purchase price unless either: (i) after “reasonable inquiry” it has “no reason to believe” that the vendor is a non-resident; or, (ii) a tax clearance certificate is obtained. When the vendor is a limited partnership with numerous limited partners, the obligation to conduct such due diligence would be problematic, to say the least. It is to be expected, then, that the agreement of purchase and sale would require the partnership—or, more properly, the general partner on behalf of the partnership—to represent and warrant that Canadian-resident partners are so resident and to provide tax clearance certificates for the rest.

The difficulty of obtaining tax clearance certificates from any number of non-resident investors is largely relieved by administrative concession. The CRA’s position as stated in paragraph 10 of Information Circular 72-17R5 is that a single application may be made on behalf of all non-resident partners provided that the application includes a complete listing of the non-resident partners together with their Canadian and foreign addresses, identification numbers, percentage ownership and their portion of the tax payment or security therefor. Separate tax clearance certificates are then issued for each partner and each partner must file its own Canadian income tax return to report the gain or loss.

Recent amendments to the Tax Act relieve the purchaser from the withholding and remittance obligation if: (i) the purchaser concludes after “reasonable inquiry” that the vendor is resident in a given treaty country; (ii) the sale proceeds would be exempt under the particular treaty; and, (iii) the purchaser provides the required notice to the Minister. Previously, then, a purchaser was relieved of its withholding and remittance obligations only if its reasonable inquiry disclosed that the vendor was a resident of Canada. Now, a purchaser is relieved of such obligations if its reasonable inquiry discloses that the vendor is a non-resident but is nevertheless entitled to a treaty exemption.

IV. Conclusion

As stated at the outset, it is critical that non-residents obtain proper Canadian legal advice before entering the Canadian market. The long-term tax consequences of the various available structures vary significantly and opportunities for tax savings can be considerable.

* * This article is intended only to inform or educate. It is not legal advice.  Be sure to contact a lawyer to obtain legal advice on any specific matter.

 

Patrick Westaway is Tax Counsel to Sorbara, Schumacher, McCann LLP, a full service law firm based in Waterloo, Ontario. Patrick advises on a broad range of Canadian taxation issues such as corporate tax planning, structuring inbound investments, corporate reorganizations, cross-border financings, tax opinions for public disclosure documents, tax assessments, personal tax matters, wealth preservation, and on federal and provincial sales tax matters (HST/GST/PST). Patrick also practices corporate and commercial law with an emphasis on the implementation of matters related to his tax planning practice.

Print This Article

 

Tax Law – Patrick Westaway 

Those who sell goods or services in Canada have always to consider whether to become a ‘registrant’ under Canada’s federal Excise Tax Act. For residents of Canada, the issue is simple. If revenues from the sale of goods or services in Canada that became due in the four preceding calendar quarters exceed CDN$30,000.00 then registration is required unless, in broad terms, an exemption can be found. Unfortunately, matters are considerably more complicated for non-residents of Canada.

Overview of Canada’s Sales Tax System

By way of an overview, Canada has both federal and provincial levels of sales tax. The federal sales tax is referred to as the Goods and Services Tax (“GST”) whereas sales tax at the provincial level is generally referred to as provincial sales tax (“PST”)—except in Quebec, which refers to its sales tax as QST. In the provinces of Ontario, Nova Scotia, New Brunswick and Newfoundland & Labrador, the administration of GST and PST has been combined and the result referred to as Harmonized Sales Tax (“HST”). British Columbia had adopted the HST but reverted to its old PST system as of April, 2013. For simplicity’s sake, this article refers throughout to GST but such comments apply equally to HST.

GST applies at a rate of 5% of the value of the consideration for the supply, i.e., the sale price. The various PST rates range from 5% to 10% and, in non‐HST provinces, is variously applied to the net or gross sale price (sale price with or without GST). In Ontario, the total HST is 13% (GST of 5% plus PST of 8%). Tax advice should be obtained to determine whether and at what rate sales tax applies in given circumstances.

A key element of this federal system is a set of rules—known as the “place of supply” rules—to determine which province has jurisdiction to tax a given transaction. Simply stated, the province with jurisdiction is generally the one in which the supply occurs. If, for example, the goods supplied are tangible personal property then the relevant province is generally the one in which the goods are delivered or made available to the recipient. If the supply is of real estate then the relevant province is generally the one in which that real estate is located. If the supply is of intangible personal property, jurisdiction will depend on a number of factors, including the place in which the property can be used and the location of the purchaser. Different intangible properties will, however, be subject to different rules. When services are supplied, the relevant province is generally determined according to the home or business address of the purchaser, although, again, specific rules apply for certain types of services. The place of supply rules are extensive and the above examples are general and for illustrative purposes only.

When property and services are brought into an HST province from another province (whether or not such other province is also an HST province) or from outside Canada for consumption, use or supply in that HST province, the supplier is required to self‐assess since no actual purchase and sale occurs.

Significance of being a “registrant” under Canada’s Excise Tax Act

So what is the significance of being a registrant? A registrant is required to withhold and remit GST on supplies made in Canada of goods and services (provided that no exemption is available) and to file periodic GST returns. On the other side of the ledger, a registrant is entitled to claim input tax credits for (deduct) any GST paid or payable by it on taxable supplies (inputs) that are used, consumed or supplied in the course of its commercial activities. The policy behind input tax credits is that GST should only be paid by consumers, not each party in the supply chain. Consequently, to the extent that the registrant’s commercial activities involve the making of “exempt” supplies, (supplies that are not subject to GST) input tax credits are not available. Perhaps inconsistently, “taxable” supplies includes “zero‐rated” supplies (supplies that are taxable at a rate of 0%) and supplies that are made outside Canada (to which GST does not apply). Input tax credits can only be claimed if the taxpayer (including non‐residents) keeps documentation sufficient to determine the amount of GST that it paid on its inputs. This documentation is, to some extent, prescribed by regulation and varies according to the cost of the particular input.

Registration requirement as it applies to nonresidents

To return, then, to the original question, when is a non‐resident required to become a registrant? A non‐resident is generally required to become a registrant under the Excise Tax Act if it carries on business in Canada. In making this determination, the Canada Revenue Agency (the “CRA”) claims a broad discretion unfettered by any clearly articulated rules. Instead, the CRA has published various scenarios, each with a lengthy set of circumstances, and expressed an opinion in each instance. It is left to non‐residents and their tax advisors to discern patterns among these scenarios and findings.

In the context of non‐residents selling goods worldwide, for example, the CRA emphasises the solicitation of orders and delivery of goods in Canada. Yet these factors alone are insufficient to find that the non‐resident carries on business in Canada. Something more is always required. That something more may be the place of contract, which itself can involve subtle legal analysis, or the warehousing of goods in Canada.

Other factors, such as a Canadian bank account will be considered but are less significant.

Interestingly, the CRA has indicated that it does not consider it relevant that a non‐resident who sells machinery into Canada also sends its employees into Canada to install that machinery. Such activity is regarded as being merely ancillary to the sale. One must be careful when relying upon such statements, however, since there may well be situations in which the time required for the installation or the amount of the purchase price allocable to such installation services would draw a different response from the CRA. Each situation must be carefully considered in view of its own circumstances.

In addition to the foregoing considerations, special rules require non‐residents to register for GST in the following circumstances, subject, as always to qualifications and exceptions:

  • a non‐resident sells admissions to a place of amusement, seminar or other activity or event in Canada, including concerts and sporting events;
  • a non‐resident sells books, newspapers or periodicals in Canada;
  • a non‐resident organises a convention in Canada; or
  • a non‐resident exhibitor at a convention in Canada brings into the country goods for sale to delegates.

In general, registration must occur before the thirtieth day following the day on which the taxable supply is first made in Canada. Non‐residents who sell admission to a place of amusement, seminar or other activity or event, however, must register before the taxable supply is made.

Conclusion

In view of the foregoing, non‐residents who intend to sell goods or services in Canada should always consult their Canadian tax advisor in advance and, ideally, before finalizing the services or sales agreement. Registration obligations, whether for tax or other purposes, the effects of such registrations and even applicable tax rates are of sufficient complexity that proper advice is always essential.

* * This article is intended only to inform or educate. It is not legal advice.  Be sure to contact a lawyer to obtain legal advice on any specific matter.

 

Patrick Westaway is Tax Counsel to Sorbara, Schumacher, McCann LLP, a full service law firm based in Waterloo, Ontario. Patrick advises on a broad range of Canadian taxation issues such as corporate tax planning, structuring inbound investments, corporate reorganizations, cross-border financings, tax opinions for public disclosure documents, tax assessments, personal tax matters, wealth preservation, and on federal and provincial sales tax matters (HST/GST/PST). Patrick also practices corporate and commercial law with an emphasis on the implementation of matters related to his tax planning practice.

Print This Article

Tax Law – Patrick Westaway

Canada’s exemption from tax on the sale of a principal residence is not just for Canadian residents. Non-residents of Canada enjoy one year of tax-exempt gains as a result of the “one plus” rule.

While it may seem contradictory, Canadian residence is not a condition of making a Canadian principal residence designation. A property can be designated as a principal residence if it is “ordinarily inhabited” in the year. “Ordinarily inhabited” does not impose a minimum time requirement. If the non-resident inhabits the property at all and the main reason for owning the property is not to gain or produce income, such property will be considered to be ordinarily inhabited by the non-resident. Provided, then, that the non-resident has not already designated another Canadian property as its principal residence for that year, a principal residence designation may be made.

The question is whether one must then be a Canadian resident to claim the corresponding deduction in respect of the designated principal residence. On a casual reading, the answer to this question is ‘yes’ since the years for which the deduction is available are described as “one plus the number of taxation years that end after the acquisition date for which the property was the taxpayer’s principal residence and during which the taxpayer was resident in Canada”. However, much depends on the first two words of this excerpt. The Canadian residence requirement qualifies only “the number of taxation years that end after the acquisition date”. Non-residents still have the benefit of the “one plus”.

What this means is that non-residents can deduct from their taxable income that portion of the capital gain that “one” is of the total number of years in which the non-resident owned the property. If the non-resident buys and sells the property in the same year then the full amount of the gain is exempt. If the non-resident holds the property for ten years then only one-tenth of the gain is exempt. Taking as an example a 10% gain on a Toronto condo purchased two years ago for $2,500,000.00, a principal residence designation is worth approximately $30,000.00 in after tax dollars. More commonly, a 15% gain on a Toronto condo purchased while under construction for $800,000.00 and re-sold post completion within one year for a 15% gain produces similar after tax savings of $29,000.00.

One must never assume the apparently obvious when tax planning for non-residents. Tax savings can generally be found when one knows where to look.

* * This article is intended only to inform or educate. It is not legal advice.  Be sure to contact a lawyer to obtain legal advice on any specific matter.

 

Patrick Westaway is Tax Counsel to Sorbara, Schumacher, McCann LLP, a full service law firm based in Waterloo, Ontario. Patrick advises on a broad range of Canadian taxation issues such as corporate tax planning, structuring inbound investments, corporate reorganizations, cross-border financings, tax opinions for public disclosure documents, tax assessments, personal tax matters, wealth preservation, and on federal and provincial sales tax matters (HST/GST/PST). Patrick also practices corporate and commercial law with an emphasis on the implementation of matters related to his tax planning practice.

Print This Article

Tax Law – Patrick Westaway

Much of a detailed and technical nature has been written about the new so-called Foreign Affiliate Dumping Rules. But what, in plain English, are these rules about? Who is affected? The purpose of this blog is not to provide a detailed discussion of these rules but merely to enable the non-tax advisor to recognize when the rules might apply and so to seek the appropriate tax advice.

Simply stated, these rules target foreign corporations that finance other foreign corporations through Canadian subsidiaries. Advisors should therefore look for Canadian corporations with both: (i) a foreign controlling shareholder; and, (ii) investment (debt or equity) in a foreign affiliate.

If this description fits and no exemption is available then the primary effect of these rules is to deem, in effect, the amount of the investment to be a taxable dividend payable by the Canadian subsidiary to its foreign parent. Alternatively, that amount is applied to reduce stated capital—in tax parlance, paid-up capital—and so to reduce the amount available to be distributed as a non-taxable return of capital in future. In either case, the end result is the application of Canadian withholding tax.

While the relevant rules surrounding potential exemptions—as set out in the October 15, 2012 draft legislation—are detailed and extensive, the general tenor is to exempt investment by a Canadian subsidiary in a foreign affiliate if the transaction is not entered into primarily for tax planning purposes. Further discussion of these exemptions is beyond the scope of this blog.

The following is a typical structure targeted by the new rules. A Canadian-resident corporation (CanCo) purchases shares of a foreign affiliate from its foreign parent (ParentCo). CanCo does not pay ParentCo and, instead, the amount of the purchase price becomes an interest-bearing debt. CanCo now has an interest deduction to apply against other income. CanCo does not, however, have an offsetting income inclusion if the foreign affiliate pays only dividends and those dividends are paid out of after-tax profits. The result is a net tax benefit to CanCo. In addition, ParentCo will be exempt from Canadian withholding tax on those interest payments if ParentCo resides in the U.S. (Canada’s tax treaty with the U.S. exempts interest payments from the 5% or 10% withholding tax otherwise applicable to dividends).

In this situation, the Foreign Affiliate Dumping Rules would apply to re-characterize the amount of the purchase price for which CanCo is indebted to ParentCo as a taxable dividend. This deemed dividend would arise at the time of the share purchase. At that time, then, ParentCo would be subject to Canadian withholding tax on that amount at the (typical treaty-reduced) rate of 5%. Conversely, CanCo would be denied deductions on future interest payments since the debt obligation would not exist for Canadian tax purposes.

Taking the above example further, there may be situations in which the Canadian corporation is ultimately controlled (for example) by a German corporation which flows interest through a U.S. affiliate able to shelter that interest income from U.S. income tax. Distributions of that interest by the U.S. affiliate to the German parent would then be exempt from U.S. withholding tax pursuant to a treaty exemption similar to that arising under Canada’s treaty with the U.S.

Other examples of affected structures as described by Canada’s Department of Finance on March 29, 2012 are as follows:

  • a Canadian subsidiary acquires shares of a foreign affiliate using that subsidiary’s own funds (a mechanism is then available for the foreign parent to extract earnings from the Canadian subsidiary without attracting Canadian withholding tax otherwise applicable to dividends);
  • a Canadian subsidiary acquires treasury shares of a foreign affiliate, either by using that subsidiary’s own funds or by using borrowed funds, when that subsidiary’s foreign parent (or another foreign member of the corporate group) already owns shares in that foreign affiliate;
  • a Canadian subsidiary acquires shares of a foreign affiliate from a foreign subsidiary of the foreign parent; and
  • a Canadian subsidiary acquires shares of a foreign affiliate from an arm’s length party at the request of the foreign parent.

Notwithstanding these specific examples, Canadian advisors should be vigilant for any structures that follow the basic pattern described in the second paragraph, above. If the basic pattern fits then Canadian tax counsel must be consulted to determine whether the rules do indeed apply and, if so, whether an exemption or other solution is nevertheless available.

The Foreign Affiliate Dumping Rules received first reading in the Commons on October 18 and apply retroactively to investments made after March 28, 2012—subject to limited grandfathering for pre-existing contractual commitments.

* * This article is intended only to inform or educate. It is not legal advice.  Be sure to contact a lawyer to obtain legal advice on any specific matter.

 

Patrick Westaway is Tax Counsel to Sorbara, Schumacher, McCann LLP, a full service law firm based in Waterloo, Ontario. Patrick advises on a broad range of Canadian taxation issues such as corporate tax planning, structuring inbound investments, corporate reorganizations, cross-border financings, tax opinions for public disclosure documents, tax assessments, personal tax matters, wealth preservation, and on federal and provincial sales tax matters (HST/GST/PST). Patrick also practices corporate and commercial law with an emphasis on the implementation of matters related to his tax planning practice.

Print This Article

Tax Law – Patrick Westaway

Multinational business requires multinational tax planning, for employees as well as employers. When sending employees abroad, it is generally up to the employer to minimize the employees’ foreign taxes and to ensure that all foreign taxes are paid and filings made. The following briefly describes the tax issues to be addressed when transferring or seconding employees to Canada.

What are the thresholds below which nonresident employees are not taxable in Canada?

The general rule under Canada’s typical tax treaty is that a non‐resident employee is exempt from Canadian income tax if three conditions are met:

(i) the employee is present in Canada for no more than 183 days in any 12‐month period beginning or ending in the fiscal year concerned;
(ii) the employee’s remuneration is paid by or on behalf of an employer who is not a resident of Canada; and
(iii) the employee’s remuneration is not borne by a Canadian permanent establishment of the non‐resident employer.

183 days

On a strict reading, a non‐resident employee could be subject to Canadian income tax for two taxation years because of time spent in Canada during a single 12‐month period. This situation arises because a single 12‐month period would frequently begin in one taxation year and end in another. It is, however, understood that the Canada Revenue Agency (“CRA”) would only tax a non‐resident for a single taxation year notwithstanding that the particular 12‐month period touches upon two.

This concept of a rolling 12‐month period was introduced by the Organisation for Economic Co‐operation and Development (OECD) in their Model Tax Convention with Respect to Taxes on Income and on Capital (“OECD Model Convention”). According to the OECD’s technical notes, the phrase “12‐month period beginning or ending in the fiscal year concerned” is intended to catch situations in which the employee’s time is allocated between taxation years. Canada’s treaties that include language similar to that introduced by the OECD Model Convention include those with the U.S., France and Germany. Under Canada’s treaty with the U.K., the criterion refers to “183 days in the calendar year concerned”. A U.K. resident could therefore be exempt from Canadian income tax despite being present in Canada for 364 consecutive days if the 182nd day were December 31st.

“Employer”

Canada’s treaty with the U.S. differs from its treaties with other countries, including the U.K., France and Germany, by substituting “person” for “employer” in the second criterion. Under the U.S. treaty, then, it is irrelevant whether the Canadian‐resident payor is the employer. If a non‐resident employee exercises its employment in Canada and is paid by or on behalf of a person resident in Canada then that employee will be subject to Canadian income tax.

Under Canada’s other treaties, such as those with the U.K., France and Germany, the employee is taxed in Canada if the Canadian‐resident payor is the employer. Whether a person is an “employer” is determined under the domestic laws of the source country.

Canada’s laws in this regard apply a substance over form approach. If a Canadian resident is the employer in fact then the employee will be taxable in Canada notwithstanding formal documentation to the contrary.

“Borne by”

The third criterion applies to situations in which the non‐resident employer allocates the cost of the employee’s remuneration to a Canadian branch. If the branch deducts the amount of that remuneration from its taxable Canadian income then the branch is considered to have “borne” that cost and the exemption will not be available.

De minimus exemption

Canada’s treaty with the U.S. also differs from its treaties with other countries by providing a de minimus exemption: if a non‐resident employee’s remuneration in respect of employment exercised in Canada is CDN$10,000.00 or less in a given calendar year then that employee is not subject to Canadian income tax. Unfortunately, this exemption is not available to residents of Germany, the U.K. or France.

What are the employer’s withholding and remittance obligations?

Employers are required to withhold and remit Canadian income tax regardless of whether a treaty exemption applies. If, however, a treaty exemption is available, the employee or the employer (with the employee’s authorization) may apply for a waiver. The waiver application should be made 30 days before employment in Canada begins and must provide information as to the applicability of the treaty exemption relied upon, a copy of the employment contract and sufficient information or documentation to satisfy the CRA that the employee is resident in the treaty jurisdiction. If a waiver is made after remuneration is paid to the employee then the waiver will only apply to subsequent payments.

This waiver applies only to the employer’s withholding and remittance obligations. The employer is still legally required to open a Canadian payroll account with the CRA, to issue a T4 slip to each employee who comes to Canada and to file copies, together with a T4 Summary, with the CRA. The T4 slip is the document on which an employer reports to each employee the amount of their Canadian taxable income and the amount of Canadian income tax withheld and remitted. The argument for maintaining these obligations in the face of a waiver is that employees must have their T4 Slips to file with their Canadian income tax returns—which, the CRA submits must be filed notwithstanding that no Canadian income tax is payable and the penalty for failing to file would be nil.

Regarding social security payments, Canada’s social security agreements with other countries exempt non‐resident employers from the obligation to withhold and remit contributions to the Canada Pension Plan. In order to qualify for these exemptions, the period of the non‐resident employee’s employment in Canada cannot exceed specified time limits. In respect of employees resident in the U.S., the U.K. or Germany, the period of employment is not to exceed 5 years. Under the agreement with France, the period is 3 years.

Finally, premiums are not payable into Canada’s mandatory employment insurance program if premiums in respect of the employment exercised in Canada are payable under the unemployment insurance laws of the non‐resident employee’s home jurisdiction.

What are the employee’s filing obligations?

As stated above, non‐resident employees are legally required to file Canadian income tax returns regardless of whether the above waiver has been obtained. However, since the penalty for failing to file is calculated as a percentage of the tax owing, the penalty applicable to an individual for failing to file would be zero.

In the absence of a waiver, the issue for non-resident employees is the potential for double taxation until a foreign tax credit can be obtained the following year in the employee’s home jurisdiction. A typical solution is for an employer to pay the Canadian income tax on behalf of the employee. This creates a taxable benefit which in turn increases the tax liability, the tax paid by the employer and so, again, the taxable benefit. This circularity is addressed by “grossing up” the tax payment made by the employer by an appropriate percentage. The tax cost to the employer would therefore be greater than would otherwise have applied to the employee. A more cost effective alternative is for the employer to lend the amount of the tax to the employee. The loan would be repaid upon the employee’s receipt of the foreign tax credit in their home jurisdiction.

* * This article is intended only to inform or educate. It is not legal advice.  Be sure to contact a lawyer to obtain legal advice on any specific matter.

 

Patrick Westaway is Tax Counsel to Sorbara, Schumacher, McCann LLP, a full service law firm based in Waterloo, Ontario. Patrick advises on a broad range of Canadian taxation issues such as corporate tax planning, structuring inbound investments, corporate reorganizations, cross-border financings, tax opinions for public disclosure documents, tax assessments, personal tax matters, wealth preservation, and on federal and provincial sales tax matters (HST/GST/PST). Patrick also practices corporate and commercial law with an emphasis on the implementation of matters related to his tax planning practice.

Print This Article

Real Estate – Jacquelyn Johnson

If you are thinking of purchasing a home in the near future, the federal government has implemented some new mortgage rules that you need to be aware of. These new rules came into effect July 9, 2012, and will affect home buyers or owners who are mortgaging a property.

Most notably, for new government-backed insured mortgages, the amount of equity that can be borrowed against a property has been reduced, from 85% to 80% of the value of the property.

Another more contentious change is the reduction of the maximum amortization period from 30 years to 25 years. An amortization period is the amount of time it will take a homeowner to pay back the principal amount of a mortgage. This new shorter period means that the principal will be paid back quicker by the borrower, resulting in savings on the total amount of interest paid on that principal amount. However, it also means that the individual payments will be higher because there is less time to pay the principal back in full. This change has the effect of decreasing the total cost of a home a buyer is able to finance.

In making these changes, the government is attempting to help homeowners build up the equity in their homes quicker and to pay off their mortgages sooner, with the ultimate goal of strengthening Canada’s housing finance system. Finance Minister Jim Flaherty is seeking to cool down what many experts see as an “overheated” mortgage market, with many Canadians carrying debt loads that are beyond their comfort ranges. In fact, the average rate of debt to disposable income currently in Canada is an alarming 152%.

But in spite of the Minister’s aggressive push to inform the public of these new rules, a recent poll conducted for the Bank of Montreal showed the majority of Canadians are unaware of the changes.

Given that a home is the largest purchase most Canadians will make in their lifetimes, it is important to be aware of the rules and consequences relating to the mortgages used to finance such purchases.

* * This article is intended only to inform and educate. It is not legal advice.  Be sure to contact a lawyer to obtain legal advice on any specific matter.

 

Author: Jacquelyn Johnson is a Lawyer at Sorbara, Schumacher, McCann LLP, one of the largest and most respected regional law firms in Ontario. Jacquelyn may be reached at (519) 741-8010 or <jjohnson@sorbaralaw.com>.   

Print This Article

Corporate Commercial – Real Estate – David Sunday

When a landlord’s commercial premises are up for lease and the leasing broker locates an interested tenant, it is quite common for the prospective landlord and tenant to sign an agreement to lease as a first step towards putting in place a final lease agreement.

While an agreement to lease is no substitute for a final lease, it is important for prospective landlords and tenants to understand that signing an agreement to lease often has the same legal effect as signing a final lease itself.

Ontario’s Courts have said that, to be valid and enforceable, an agreement to lease must show the parties, give a description of the premises, set out the commencement and duration of the term, the rent, and all the material terms of the contract that are not just incidental to the relationship of landlord and tenant.  If these requirements are met, then an agreement to lease may be legally enforced, even though the parties did not ultimately agree on the final form of lease.

If the requirements for a binding agreement to lease are not met, then an agreement to lease will usually only be considered an “agreement to agree” or an “agreement to negotiate”.  In law, such “agreements to agree” are not generally treated as legally enforceable contracts.  However, even an agreement to agree may have enforceable provisions with respect to certain matters, such as forfeiture of deposit monies, and the entering into of an agreement to lease may trigger broker commission obligations.

Often agreements to lease contain a clause that says that the tenant will accept the landlord’s standard form of lease when presented subject only to minor modifications to make it consistent with the terms of the agreement to lease.  It is one thing to have such a clause included when the landlord’s standard form of lease is available to the tenant and reviewed before the tenant signs the agreement to lease, but potentially unfair to the prospective tenant if the landlord’s standard form of lease is not provided to the tenant until after the agreement to lease is signed.  Notwithstanding the potential unfairness, the Court’s will enforce such agreements to lease if the legal requirements set out above are met.

To avoid problems, parties to an agreement to lease should always ensure that:

  • the agreement to lease is clearly drafted and fully understood by both parties;
  • the agreement to lease clearly states whether it is intended to be a binding agreement to lease or non-binding in nature;
  • the agreement to lease clearly sets out the rights of the parties insofar as preparation and acceptance of the final lease agreement is concerned;
  • the agreement to lease clearly sets out what happens in the event the parties fail to agree upon a final form of lease (e.g., Are parties entitled to walk away? Are deposit monies forfeited?); and
  • any conditions included in the agreement to lease with respect to lawyer approval are clearly drafted, reflect realistic timelines, and confer sufficient rights as to allow for meaningful lawyer review and comment.

Before signing any agreement to lease, landlords and tenants should ensure that their interests are fully protected and should ask themselves if they could abide by the terms of the agreement if it were legally enforced even in the absence of a separate finalized lease agreement.

* * This article is intended only to inform or educate. It is not legal advice.  Be sure to contact a lawyer to obtain legal advice on any specific matter.

 

Author: David Sunday is the Group Leader in the Municipal, Land Use & Development Law Group at Sorbara, Schumacher, McCann LLP, one of the largest and most respected regional law firms in Ontario. David may be reached at (519) 741-8010 or<dsunday@sorbaralaw.com>.

Print This Article


WEBSITE © SORBARALAW