16 May 2018 IFA Finance Roundtable
This summarizes the oral responses provided at the IFA Finance Roundtable held on May 16, 2018 at the Telus Centre in Calgary. The Finance Canada speakers were:
Brian Ernewein, Department of Finance, General Director, Legislation, Tax Policy Branch
Dave Beaulne, Department of Finance, Tax Legislation Division
We have also provided brief summaries of the questions posed by Stephen Bowman (Bennett Jones LLP) and David Weekes (Stikeman Elliott LLP). The session comenced with an overview of legislative and international developments by Brian Ernewein, which we have not summarized, except that we have summarized one of those comments (respecting s. 15(1.4)(e)) at the foot of this summary.
Q.1 – Update on Multilateral Instrument
Could you provide us with any updates on the government’s progress toward ratifying the MLI, and as to when there may be changes to Canada’s provisional reservations and optional items?
Brian Ernewein: As stated in the 2018 Budget, we attach a high priority to it. As with all international agreements, the MLI is subject to a 21 sitting-day period. The MLI was tabled earlier this year and has now gone through the 21 sitting-day period.
The next step in the process is legislative implementation. We have reserved on all optional parts of the MLI other than binding arbitration. The binding arbitration component reflects our own prior commitment, as one of the G7 countries, to binding arbitration.
The process on the optional items is that reservations can later be withdrawn, but the reverse is impossible – we cannot later reserve on an item that we had not reserved to begin with. That is the basic modus operandum driving our reservation decisions.
We will be accepting more optional items, but no announcement is being made today what they will be.
We are obligated to declare ourselves when the ratification accession is tabled, so at the very latest we will have to declare ourselves by then. It is possible we will do so beforehand, but that has yet to be determined.
We are working on the implementing legislation, and there is a possibility that it will be tabled before the summer. We would like that to be the case, but it is not certain.
Q.2 – LOB and MLI
Canada noted at the time of signing that it intended, where possible, to adopt limitation on benefits provisions through bilateral negotiations. Is that something Canada is already starting to do in its current treaty negotiations?
Brian Ernewein: That is the case. We have said that we are interested in pursuing, in certain cases, a limitation on benefits approach, rather than the principal purpose test, in our bilateral negotiations.
We are treating even our bilateral negotiations with Switzerland and Germany as a way to implement the MLI through a different route. In other words, our view is that we are adopting the PPT across the board, and I suspect that Switzerland and Germany are also taking that approach.
Q.3 – Digitalization
Could you give us an update on digitalization as it relates to the BEPS proposals, the European Commission proposals, and the suggestion in March of a digital services tax and a digital permanent establishment model for taxation?
Brian Ernewein: There is an issue on the sales tax or VAT side, and also on the income tax side.
The VAT side is fairly clear (although a bit murky in relation to Canada). BEPS Action Item 1 included a recommended approach to deal with non-resident digital service-providers. It gave a model for how to apply the VAT in those circumstances, and we were involved in that discussion and contributed to the design of the system.
On the income tax side, there is much more left to resolve. We did not land on a recommendation in 2015 – the conclusion was essentially to see what was resolved on other Action Items, and to come back to this issue in 2020. Some members in Europe became impatient about this, and required that there be an interim report by 2018, and that report was completed earlier this year.
The report included an interim proposal for a tax that could be applied as, essentially, a proxy for income tax. I think it is fair to say that the report damned that approach with faint praise. Many countries, including ours, take issue with that approach, as the proxy tax was essentially based on gross revenues.
Having said that, there is a constituency of European countries that see this as a current political problem and want to deal with it sooner rather than later. I do not think that Finance sees this to be urgent enough to warrant a sub-optimal interim measure, but we are interested in looking for a longer-term solution, or assessment of whether digital is special – and whether there is a way to deal with the nexus issue and the profit-allocation issue, or whether the sphere of concern is broader than digital, and requires a more fundamental change in approach.
The positions of the different European countries seems very fluid right now.
At any rate, there is political pressure in the long-term to find solutions for this kind of activity and enterprise.
Q.4 – U.S. Tax Reform
In Budget 2018, the Department of Finance indicated that it is conducting detailed analysis of the US federal tax reforms to assess their financial impact on Canada.
Can you provide any information about the anticipated process, and the timing for Finance’s work, and to what extent the tax or business community will be involved in that process?
Brian Ernewein: Canada’s rate advantage has evaporated. We have to take state and provincial taxes into account as well as federal taxes. On a statutory rate-basis, we are perhaps a percentage point higher than the US based on average provincial rate vs. average state rate. On a marginal effective tax rate, we might be slightly above or below the United States depending on your approach, but the main point is that our substantial advantage has dissipated with the new US tax rate.
The new US tax rate is not the only thing going on in the US. The revenue numbers make that clear – even though there was a 40% reduction in the headline tax-rate, from 35% to 21%, there is only an 8.5% decrease in revenues from corporate taxes, once the repatriation taxes are taken into account.
We are trying to work with the advisory and industrial firms in making evaluations. We like to conduct our own analysis and then compare notes. As of about a month ago, our discussions were mainly with the accounting houses, which had done some of the early work in providing their impressions. More recently, we have been having discussions with some of the Associations. Just last week, we met with the Tax Executive Institute, and had a very helpful conversation about the impacts of this.
We expect to continue these discussions over the next few months, and perhaps make an assessment in the fall as to whether any changes may be required.
Q.5 – U.S. Repatriation Tax and U.S. Citizens
This question deals with the plight of individual US citizens residing in Canada who, under the US tax reform, if they own 10% or more of a Canadian corporation, are subject to a one-time repatriation tax. They can pay that tax over eight years, but the tax is triggered in 2017. The tax is around 9% of retained earnings of the corporation represented by non-cash assets, and 17.5% for earnings related to cash assets.
Neither Canadian domestic law not the Canada-US treaty appears to allow such taxpayers any relief in Canada for the portion of the tax that relates to Canadian-source retained earnings.
Can you comment on this issue?
Brian Ernewein: We are aware of the issue. This is just the latest manifestation of the special issues that can arise when two different countries apply residence-like taxation to the same person. There is the ordinary taxation, involving Canadian resident shareholders of Canadian corporations earning Canadian-source income, where the personal and corporate tax are all integrated and internal.
Then there’s the extraordinary taxation involving a US citizen who owns a Canadian corporation. Even leaving aside the 2017 US tax reform, there are issues involving overlapping taxation between Canada and the US. In those cases the tax is generally matched, because the taxable event is the same in each jurisdiction – e.g. dividends paid to the individual will trigger personal tax in Canada and the US. There is usually some prospect for tax-matching.
In this case, the US has reached down with Subpart F rules, and sought to tax on an accelerated basis where Canada does not. It is difficult or impossible to match that up effectively.
The choices are pretty hard. You might be able to get a credit for the underlying corporate tax if you make a s. 962 election, but that will only apply where low corporate tax rates are applicable, and only cover part of the low repatriation tax. You might be able to pay the income up in order to trigger lots of Canadian personal tax, which would give more room for foreign tax credits, but that may be a hefty price to pay, and you might not even get credit for all your tax.
We recognize there is an issue here. We think it’s a manifestation of US citizenship taxation, which is not unlike other issues for those who are US citizens. Those of you who are US citizens with tax-free savings accounts will know what I’m talking about.
Whether or not we can do something with the US to help on this is unclear. I do not think they will turn off the repatriation tax. We would certainly be prepared to ask but there is not much expectation that that would occur. Certainly that is not something that US Treasury believes they can do it would have to be an Act of Congress. Whether or not something can be done to improve or make more flexible the timing of it, so that earnings paid out in the next several years would somehow attract Canadian personal taxes to produce matching is something we can discuss. But it is a real challenge.
We have raised this with Treasury and the Minister intends to raise it himself, and there may be demarches into Congress as well.
Q.6 – US Interest Deductions and S. 95(2)(a)(ii)
S. 95(2)(a)(ii), which deems income to be income from an active business, requires that the payment that is received have been deductible by the payor. There are some rather old and very helpful rulings from the CRA dealing with deferred interest as a result of the s. 163(j) rules in the US, but the question arises, under the tax reforms, whether the substantial rewriting of interest deductibility in the US is going to raise any issues.
Can Finance comment?
Dave Beaulne: This is really a question for the CRA, but they did not have time to properly address it, so I am relying on my personal experience to some extent, in consultation with my colleagues from Finance and a little bit from Rulings.
We think that the existing position respecting s. 163(j) will still apply, meaning that if interest is denied, but is allowed to be carried forward indefinitely under the new US interest limitation rules, it should be possible to recharacterized it under s. 95(2)(a)(ii).
If interest is permanently denied, under say the hybrid rule, that should also be okay under s. 95(2)(a)(ii)by virtue of Reg. 5907(2)(j). But, again, that’s really a question for the CRA, so if people want more certainty on that, I invite them to contact Rulings.
Q.7 – T1134 Filing Due Date
Is CRA considering changes on the T1134 compliance deadlines?
Dave Beaulne: We have received a lot of feedback on this, and very little of it was positive.
We are always considering changes – that is what the consultation process is about. No decisions have been made. I understand that the Joint Committee is imminently going to issue their submission to us on this. I hope they have not finalized it yet, because I would like to throw out a few things that I would like them to address in their submission.
I want to raise the idea that when you submit your FAPI information effectively 15 months after year-end, your corporate tax return is filed six months after year-end, so therefore your Notice of Assessment is usually issued within a couple of months of the six-month filing deadline. It seems kind of unfair that the statutory reassessment period for FAPI, for everything runs from the assessment of the T2 filing and not from the T1134 filing.
We were asked what the objectives were of the 2018 Budget proposal. We received comments (that I have compiled from our colleagues) and I will go through most of them.
Obviously, we wanted to be able to accelerate the CRA audits. Many people would say that CRA does not really get to them until after three years anyway. Maybe that is true, but there is still a selection process that’s done upfront – or, at least, not three years down the road - and we would like to speed that up. The Department of Finance uses that information a lot as well, and would benefit from an accelerated receipt of that information. There was a comment made yesterday to the effect that, with staff turnover, corporate memory is lost, so that we suggest that moving from 15 months to 6 months may improve corporate memory.
Three or four people have given us the surprising comment that they don’t rely on the questionnaires in the T1134 to help them determine what their FAPI is for T2 reporting. Apparently they have a separate process, and apparently they know where they have FAPI, so that they do not have to ask the questions of their foreign affiliates. We find that interesting. So I throw that out for your consideration.
Most people have acknowledged that 15 months is too long. Most people have acknowledged that 6 months is too short. That’s fair. I would point out that the US, based on my reading of Form 5471, seems to align their 5471 Form reporting with their corporate tax return deadline. Now I know the comeback to that is that the US at least permits the filing of corporate tax returns nine and a half months after year-end. I will stop there.
Q.8 – Eligible Controlled Foreign Affiliates (ECFAs)
For the foreign affiliate reorganizations referred to in ss. 88(3) and 95(2)(c), (d.1) and (e), transfers of capital property are deemed to have occurred on a tax-deferred basis unless the taxpayer elects higher proceeds through a “relevant cost base” (RCB) election. The RCB definition was amended in 2013 (generally effective August 19, 2011) to allow the election only where the FA is an eligible controlled foreign affiliate (ECFA). To be an ECFA the taxpayer’s participating percentage must be not less than 90%. Under the definition of participating percentage, the participating percentage of a taxpayer in a controlled foreign affiliate is deemed to be nil if the FAPI for the year is less than $5,000, which means that in such cases the FA appears not to qualify as an ECFA. Any comment on this?
Dave Beaulne: This question came from us.
We wanted to acknowledge that there is a drafting error in the definition of eligible controlled foreign affiliate. The paragraph in question where the drafting error occurs is meant to remove the circularity that otherwise exists in situations where a taxpayer’s participating percentage in a foreign affiliate relies on the quantum of the affiliate’s FAPI which, in turn, will be affected by the RCB election.
Thus, the circularity. The conclusion is that the current rule requires the foreign affiliate to have FAPI in excess of $5,000 in order to make the election. However, now that it has been brought to our attention, we will be considering whether or not to remove that wording.
Q.9 – Pertinent Loans and Indebtedness (PLOIs)
S. 15(2.11) PLOI elections can be made to elect out of s. 15(2) only by corporations resident in Canada (CRICs) if controlled by a non-resident corporation. However, similar s. 15(2) issues arise on loans made by CRICs to non-resident sistercos, where they are both controlled by non-resident individuals or a Canadian-controlled private equity fund. Would Finance consider extending the PLOI rules to these types of structures?
Dave Beaulne: We appreciate the submission, but given that we just have just been alerted to it, we have not had time to really consider it, so I do not have much of an answer for you. However, I will provide an explanation for why foreign corporate control is required. As many of you know, the PLOI regime was enacted during the FA dumping deliberations and that was the trigger, FA dumping. We are happy to give it further thought. However, it seems that there may be broader issues to be considered with respect to these structures. So it could take some time.
Q.10 – Repayment of Back-to-Back Upstream Loans
The upstream loan regime in s. 90 provides for income inclusions under s. 90(6) for certain loans and indebtedness owing to FAs, and offsetting deductions on repayment under s. 90(14). The rules contain back-to-back loan provisions in s. 90(7). More recently, the shareholder loan rules in s. 15 were amended to add s. 15(2.17) dealing with back-to-back loans, together with deemed repayment rules in ss. 15(2.18) and (2.19).
Is Finance considering similar repayment rules in s. 90?
Dave Beaulne: We planted this one because we wanted to advise people that we recently issued a comfort letter to the effect that we will be recommending to the Minister to amend the law to introduce repayment rules similar to the ones in s. 15. It will be effective for repayments after April 10th, 2018.
Comment on S. 15(1.4)(e)
Brian Ernewein: I mentioned earlier the 2016 technical pack. Most of its proposals were enacted in the second Budget Bill for 2017. However, in the case of the foreign demergers rule in s. 15(1.4)(e) – for which we had a proposed change to try to improve the operation of that rule - there were some issues that were identified with it. We did not proceed with it, but we intend to, and we will be coming back out with changes to deal with that. Whether we leave it in s. 15 or rejig it to give it a somewhat different application and scope we are still discussing. I think if we do change it substantially, we likely would want to put it out again for comment before proceeding with formal introduction. That’s for you information so that you know that that change is pending.