CANADA - 2019 Federal Budget
On 19 March 2019 Finance Minister Bill Morneau presented the 2019 Federal Budget, which introduced several key measures affecting both businesses and individuals. In this article we summarise the main international business tax proposals.
Changes to transfer pricing rules
For tax years beginning on or after 19 March 2019, the Income Tax Act (ITA) will be amended to clarify that its transfer pricing rules will have priority over its other provisions. However, the current exception to the application of the transfer pricing rules where a Canadian resident corporation has an amount owing from, or extends a guarantee in respect of an amount owing by, a controlled foreign affiliate, will remain in force.
The ITA transfer pricing rules will be amended so that the definition of ‘transaction’ will apply to a broad range of situations that may arise in the context of a multinational enterprise’s operations. In addition, the ITA will be amended to provide that the definition of transaction used in the transfer pricing rules will also be used for the purposes of the extended reassessment period relating to transactions involving a taxpayer and a non-resident with whom the taxpayer does not deal at arm’s length. This will apply for tax years for which the normal reassessment period ends on or after 19 March 2019.
Changes to foreign affiliate dumping rules
The foreign affiliate dumping (FAD) rules aim to counter erosion of the tax base resulting from transactions in which a corporation resident in Canada (CRIC) that is controlled by a non-resident buys or otherwise invests in a foreign affiliate using borrowed or surplus funds. Generally speaking when the FAD rules apply, the following can result:
- Paid-up capital (PUC) of the CRIC will be ground down to the extent of the investment in the FA.
- A dividend will be deemed to have been paid by the CRIC to the non-resident corporation, which can trigger withholding taxes of 25% (possibly reduced by a tax treaty).
- A Pertinent Loan or Indebtedness (PLOI) election can be made in some situations.
The Budget 2019 proposals extend the application of the FAD rules for transactions and events that occur on or after 19 March 2019 by replacing the word “non-resident corporation” with “non-resident persons” in the draft legislation. Non-resident persons include:
- A non-resident individual
- A non-resident trust
- A group of persons that do not deal with each other at arm’s length, comprising any combination of non-resident corporations, non-resident individuals and non-resident trusts.
The Budget proposals also include an extended meaning of when persons (or a group of persons) can be considered “related” with respect to the application of the FAD rules. The proposal works as follows:
- A trust is deemed to own 100 shares of the CRIC;
- A beneficiary of a trust is deemed to own their proportion of the fair market value of the interest in the trust; and
- If the trust is a discretionary trust, the beneficiary is deemed to own all shares of the CRIC owned by the trust.
The impact of the proposed changes in the Budget is far reaching and extends to many situations that do not fall within the spirit of the FAD rules by the Department of Finance. For example, the proposed changes could capture the following situations:
- Individual Canadian shareholder controls a Canadian corporation which in turn controls a non-resident corporation. If the individual becomes a non-resident of Canada, to the extent the Canadian entity makes an investment into the non-resident entity, the FAD rules noted above will apply.
- Canadian-controlled private corporation (CCPC) which controls a non-resident corporation that undergoes an estate freeze; as a result, a Canadian trust is created (common planning among CCPCs) and the trust now controls the CCPC. If a beneficiary of the trust becomes a non-resident of Canada and the CCPC makes an investment into the foreign entity, the above FAD rules may now apply.
- Transactions resulting in a mix of Canadians and non-residents (individuals, trusts or partnerships) owning a Canadian company that owns another foreign entity. This could be the case in takeover transactions, reverse takeover transactions or private equity investments in a Canadian target that has FAs. It is a question of whether the non-residents will be dealing at arm’s length.
Also, the way the rules are currently drafted may require the CRIC to do valuations every time an investment is made in the FA — this would practically be very difficult and costly for many private corporations.
Update on combatting aggressive international tax avoidance
It was also reiterated in the Budget that the Government is committed to safeguarding Canada’s tax system, and to that end continues to be an active participant in the OECD’s Base Erosion and Profit Shifting (BEPS) initiative.
Canada is also taking the necessary steps to implement and bring into force the Multilateral Instrument (MLI) implementing tax treaty-related measures to prevent BEPS. This is an important tool in facilitating some of the BEPS measures and in combatting international tax avoidance.