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Tax Law – Patrick Westaway

The Origin …

The unlimited liability company is an archaic form of corporation tracing its origins back to the United Kingdom’s Companies Act of 1862. In these early years of the Corporation, limited liability required more than mere incorporation. It required a Royal Charter. And so, ULCs were commonplace and have endured in the U.K. to this day.

In Canada, however, the ULC was lost to history and forgotten over the intervening one and a half centuries. Then, in the mid-1990s, a U.S. tax practitioner discovered a surviving ULC in the Canadian province of Nova Scotia. Having all the criteria of a corporation except one—limited liability, this last of the Canadian ULCs had important and hitherto unforeseen uses for U.S. tax practitioners.

Since 1997, U.S. taxpayers can choose not to recognize a Nova Scotia ULC as a corporation for U.S. tax purposes. A ULC can be ignored or, in tax parlance, treated as a ‘disregarded’ entity. Thus, while a ULC is a corporation like any other for Canadian tax purposes, U.S. shareholders can deduct a ULC’s losses against their own income, just as they would the losses of a partnership or sole proprietorship. Additional uses include the step-up in the cost base of capital assets when the ULC is used as an acquisition vehicle, an increase of foreign tax credits and more besides than can be usefully described here. So popular did Nova Scotia’s ULC become, and so lucrative for that province’s government, that the provinces of Alberta and British Columbia amended their corporate statutes to reintroduce the ULC in their jurisdictions as well.

The Death…

Then, after just ten years, the situation changed. In 2007, the Fifth Protocol amended the Canada-U.S. Tax Convention (1980) to deny treaty benefits to U.S. recipients of income, profits or gains paid by ULCs. What this means is that payments of dividends, rents, royalties, interest and similar passive forms of income remain subject to the full 25% tax rate under Canada’s Income Tax Act, without the usual treaty reductions and exemptions. Effective as of January 1, 2010, this change sounded the death knell of the ULC. But, is the ULC truly dead?

And the Resurrection

The Canada Revenue Agency has endorsed a seemingly superficial solution to the Fifth Protocol. According to its plain wording, the treaty amendment applies only to amounts that would be treated differently for U.S. and Canadian tax purposes by reason of the ULC being ‘fiscally transparent’ (a disregarded entity) under U.S. law. Consequently, this limitation can be avoided, first, by increasing stated capital by the amount that would otherwise be distributed as a dividend and then distributing the amount of this increase as a non-taxable return of capital.

The addition to stated capital results in a taxable dividend for Canadian tax purposes. Since this is a non-taxable event in the U.S. regardless of whether the ULC is fiscally transparent, it cannot be said that the treatment differs in the U.S. by reason of the ULC being a disregarded entity. The treaty therefore continues to apply, reducing the applicable rate from 25% to either 5% or 15%, according to whether the dividend recipient owns more or less than 10% of the ULC’s voting shares. Next, the subsequent distribution of stated capital is a non-taxable event in both jurisdictions, regardless of the disregarded nature of the ULC. Treaty protection at this stage is therefore both available and unnecessary.

One may rightly wonder why this particular treaty amendment was made at all.

* * 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.

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Tax Law – Patrick Westaway

Non-residents of Canada who sell Canadian assets must determine whether such sale gives rise to a Canadian tax liability. If it does, it is important to obtain what is colloquially called a section 116 certificate, in reference to the governing provision of Canada’s Income Tax Act.

What kinds of property are taxed?

Canada claims jurisdiction to tax non-residents on sales only of “taxable Canadian property” (“TCP”). TCP generally includes Canadian real estate, assets used in a business in Canada or private company shares (or interests in a trust or partnership) that derive more that 50% of their value from Canadian real estate (or certain resource properties) at any time in the past five years. Shares of a public company or mutual fund are treated the same as private company shares if the taxpayer together with non-arm’s length persons owns 25% or more of the issued shares or trust units.

What is the relevance of Canada’s tax treaties?

TCP used to include all private company shares, which were then exempt under Canada’s tax treaties provided that they did not derive their value from Canadian real estate, as above. Section 116 certificates were required in those situations in order to invoke the treaty exemption and avoid the tax. Now that treaty-exempt categories of assets are generally excluded from the definition of TCP to begin with, the reason for obtaining a section 116 certificate is to reduce rather than avoid the amount of Canadian income tax on the sale.

What is the benefit of a section 116 certificate?

In the absence of a section 116 certificate, the purchaser is required to withhold and remit 25% of the purchase price. Since the Canada Revenue Agency (“CRA”) will have no information as to the vendor’s cost base in the assets, this 25% rate applies to the full amount of the purchase price rather than to the amount of the capital gain alone. If the vendor obtains a section 116 certificate, it will pay to the CRA tax only in the amount of 25% of the capital gain.

How do I apply for a section 116 certificate?

Form T2062 is to be filed with the tax services office—“TSO”, as distinct from the tax “centre”—for the area in which the property is located. If the vendor is not registered for Canadian income tax purposes then the vendor must so register by filing Form RC1 at the same time as the T2062. The supporting information to be filed with the T2062 varies according to the nature of the property and vendor. A checklist is attached to the T2062 at http://www.cra-arc.gc.ca/E/pbg/tf/t2062/t2062-08e.pdf. In general, the vendor must provide identification and evidence of their cost base and anticipated sale proceeds.

As a practical matter, a vendor may not have the funds with which to pay the tax until the sale proceeds are received on closing. This creates a problem since the section 116 certificate is not issued until the tax is either paid or security acceptable to the Minister of National Revenue is given therefor. This is addressed by filing the T2062 and requesting a comfort letter in advance of the section 116 certificate. The comfort letter identifies the amount of tax payable and relieves the purchaser of liability in excess of that amount. The amount withheld and remitted is then the correct 25% of the capital gain rather than 25% of the entire purchase price. The purchaser then has 30 days following the end of the month in which the sale occurs to remit the funds and the section 116 certificate is issued following payment.

Failure of the purchaser to meet these obligations causes the purchaser to become liable for the tax, in which case the purchaser must then pursue civil remedies to recover against a vendor who may then have no further assets in Canada.

* * 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.

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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.

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Tax Law–Patrick Westaway

Tax credits represent one of the most confusing aspects of operating an animation production company; and, within the morass of jargon, rules and paperwork is one particular issue which must be understood by any animation professional thinking of going independent.

Among the potentially available credits is one familiar to every animation production company operating in Ontario: the Ontario Computer Animation and Special Effects (OCASE) tax credit. This credit represents a refund of 20% of eligible Ontario labour expenditures for eligible computer animation and special effects activities. In practical terms, labour expenditures may represent as much as 70% of the operating budget (excluding depreciation and interest and making certain assumptions regarding format, quality and, in the case of a television series, whether the production is the first or a subsequent season—all of which affects the size and salaries of the production team). In ballpark terms, then, the OCASE tax credit can represent a subsidy of as much as 14% of the entire operating budget. The OCASE tax credit is therefore essential to covering costs and turning a profit.

Activities that qualify as eligible labour expenditures cover the full pre-production and production range. Editorial, however, is excluded, as is post-production. It should also be noted that salaries and wages of individuals whose activities are not wholly devoted to eligible computer animation and special effects activities qualify only to the extent that they are so devoted. The problem arises when any of the foregoing employees decide to go independent, incorporate a service studio and ask the production company to outsource.

The devil lies in the definition of “Ontario labour expenditure”, which includes fees paid to a company only if the company is wholly owned by one individual and that individual provides ‘principally’ all of the services personally—the OCASE tax credit differs from every other tax credit in this respect. If, therefore, one has employees or fellow shareholders, clients cannot pay the services company but must instead pay the individual. How, then, without incorporating and hiring employees, can one build a services studio beyond a one-person shop?

The solution is to discount fees to compensate the client for the loss of the tax credit. The service studio would then make up the shortfall by filing its own claim for the OCASE tax credit. It must be recognized, however, that this creates a cash-flow issue for the service studio since the OCASE claim cannot be filed until after the end of the taxation year in which the services are performed. Worse still, the queue at the Ontario Media Development Corporation (OMDC) is currently forty weeks. The OMDC’s review typically then takes one week, after which time the certificate is mailed to the studio who must then submit it, together with supporting materials, to the Film Services Department of the Toronto Tax Services Office (TSO). The policy of the Toronto TSO is to review applications within sixty days, which, if all is in order, it then sends to the Tax Services Centre in Sudbury for payment. The service studio must therefore be sufficiently capitalized to wait between one and two years for the payment of the OCASE tax credit.

This point illustrates how important it is to understand the OCASE tax credit and other available tax credits in advance of budgeting, financing and bidding for projects as well as the necessity of getting the right professional support.

 

***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.

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.

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Municipal, Land Use, and Development – David Sunday and Lynn Dramnitzki

Municipalities are finding it increasingly difficult to fund the growing cost of local services and other municipal operations. Financial support from other orders of government is limited, while increases in property taxes often face stiff resistance from the electorate. While certain municipalities have been given special powers to assess and collect tax other than just property taxes, most municipalities must rely on property taxes as their principal means of funding many of the services they provide. Read more…

* * 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.

Originally published in Municipal WorldApril 2014.


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