Potential application where foreign company funds a foreign trust to buy shares of foreign parent before their transfer to Canadian employees (p. 18)
Paragraph 94(2)(k.1) catches a situation where a non-resident contributor makes a contribution to a non-resident trust for the purpose of paying benefits to employees for services rendered to a Canadian corporation. This could happen, for example, if (a) a non-resident company that is a member of a multinational group funds a non-Canadian trust in order for the trust to buy shares of the publicly-traded parent on a stock exchange, and (b) the trust holds the shares for a short time before they are transferred by the trust under a share award plan to employees of the group worldwide, including potentially employees of a Canadian subsidiary. To the extent that the transfer of some or all of the funds to the trust by the foreign company can reasonably be considered to provide benefits in respect of services rendered by the share award recipients to a Canadian resident entity, paragraph 94(2)(k.1) would cause the transfer of funds by the foreign company to the foreign trust to be deemed to be made by a resident of Canada even though the resident of Canada has not made an actual contribution, either directly or indirectly, to the trust.
The application of paragraph 94(2)(k.1) would deem the entire trust to be a resident of Canada, unless a timely election under paragraph 94(3)(f) is made to treat a portion of the trust that is not meant for employees of a Canadian subsidiary to be a separate, fictitious, “non-resident portion trust”. If an election is made, the portion of the trust that is the non-resident portion will not be subject to Canadian income taxation.
Main-reason test generally not met for foreign commercial trusts (pp. 19-20)
“[N]on-resident entity” is defined, at subsection 94.1(2), as including a trust that is an exempt foreign trust, other than one described in paragraphs (a) to (g) of the definition of “exempt foreign trust” in subsection 94(1). Accordingly, while section 94.1 does not have to be considered in the context of discretionary trusts (because they will not issue fixed interests and therefore will not be exempt foreign trusts under paragraph (h) of the definition of “exempt foreign trust”), it does have to be considered in the context of investments in foreign commercial trusts.
Assuming that an equity or debt interest in a foreign commercial trust derives its value primarily from portfolio investments in property of a kind enumerated in paragraph 94.1(1)(b), subsection 94.1(1) will apply if “one of the main reasons” for the taxpayer acquiring or holding the interest was to derive a benefit from portfolio investments in the relevant assets in such a manner that the taxes (whether imposed under Canadian or foreign law is not specified) on the profits, income or gains from such assets are significantly less than the tax that would have been applicable under Part I if the taxpayer had earned such profits, income or gains directly. Many if not all of the foreign commercial trusts that the authors have encountered in practice are ones that are managed by a foreign manager that does not offer a similar product in Canada, and indeed many of these trusts distribute all or substantially of all of their investment income currently. As a result, reduction of Part I tax will typically not be one of the main reasons for a Canadian taxpayer, or its controlled foreign affiliate, investing in such foreign commercial trust.
Whether s. 104(13) inclusion test is satisfied in case of foreign trust (p. 21)
[S]ubsection 94.2(3) provides for a deduction in computing the trust’s FAPI allocable to the affected beneficiary equal to that portion of FAPI that is included in the income of the beneficiary under subsection 104(13).
The relief from double taxation mechanism in subsection 94.2(3) is not without its technical challenges. First, a deduction from the trust’s income under paragraph 104(6)(b) is permitted only on “the amount that the trust claims”. A non-resident trust that is subject to subsection 94.2 (3) is one that is exempt from being deemed resident in Canada under section 94. Accordingly, it could be expected that such a trust will not file a Canadian tax return and will not be expressly claiming any deductions under the Act. If the trust does not claim a deduction for distributed income in a Canadian tax return, it is not clear based solely on a textual reading of the relevant provisions that there would be a paragraph 104(6)(b) deduction that can ground a subsection 104(13) income inclusion for the beneficiaries who received distributions. That uncertainty in turn would affect the availability of the double taxation relief in subsection 94.2(3), which reduces FAPI allocable to the affected beneficiary by the amount of the FAPI of the trust included in the beneficiary’s income under subsection 104(13). However, the concern can be diminished by a reading of the provision that takes purposive and contextual elements into account. Although not authoritative, the heading for subsection 94.2(3) is “Relief from double taxation”, and the Technical Notes to the provision state that “new subsection 94.2(3) ensures that amounts payable by the trust are not included in income twice”. Moreover, subsection 94.2(3) is flexibly worded, as it provides for a deduction from FAPI to be included in income under subsection 91(1) an amount equal to the FAPI amounts as “would reasonably be considered to have been ... included under subsection 104(13)”, and, arguably, it would be reasonable to consider that some of the trust’s distributed income would have been so included had the trust filed a Canadian tax return, in which case it is also reasonable to consider that the trust would have claimed a deduction under subsection 104(6) for such income. This is a plausible reading of the words of the statute and becomes even more so in light of the above-mentioned context and purpose.
It can thus be seen that a commercial trust with “fixed interests” may be able to escape deemed residence status under section 94, but where a Canadian resident or its controlled foreign affiliate is a beneficiary of such a trust, amounts may be required to be included in income in Canada in connection with such trust under section 94.1 or section 94.2.
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