15 May 2019 IFA Roundtable

This provides the written questions that were posed, and abbreviated summaries of the CRA oral responses, at the CRA Roundtable held in Montreal on 15 May 2019 at the annual conference of the International Fiscal Association (Canadian branch). The presenters from the Income Tax Rulings Directorate were:

Yves Moreno, Section Manager, International Division

Yves Grondin, International Division

The questions were orally presented by Kim Maguire (BLG) and Carrie Smit (Goodmans).

We have adopted various of our own titles. The final responses, when published under the Directorate's severed letter program, will be linked at the end of each question. CRA cautioned that their oral responses should not be relied upon unless and until confirmed by publication of their final responses.

Q.1 – Thin cap effect of contribution by non-shareholder

The thin capitalization rules set out in subsection 18(4) of the Income Tax Act (the “Act”) limit the deductibility of interest paid or payable on outstanding debts to specified non-residents, such that, in general terms, a corporation may not deduct interest based on the proportion of such debts over and above 1.5 times the “equity amount” of the corporation.

In turn, “equity amount” is defined to include, among other things, contributed surplus that has been contributed by a specified non-resident shareholder of the corporation.

Does document 9521415 still represent the CRA’s position? More specifically,

  1. Does the definition of "specified shareholder" in subsection 18(5) of the Act require a person to own shares of the corporation?
  2. Is an amount of contributed surplus contributed by a person that was a specified non-resident shareholder at the time of the contribution included in the calculation of the average referred to in the definition of “equity amount” in subparagraph 18(5)(a)(ii) of the Act where the person is no longer a specified non-resident shareholder at the time that the calculation in subsection 18(4) of the Act is made?

Summary of Preliminary Response

In general, a specified shareholder is a person who, either alone or together with persons with whom it does not deal at arm’s length, owns shares representing either 25% or more of the voting rights or 25% or more of the FMV of all the issued and outstanding shares.

Consistently with 9521415, it remains CRA’s view that: that person must own at least one share in order to be a specified shareholder; and, in order to be included in the average referred to in the equity amount definition, the contributed surplus must have been contributed by a person that is a specified non-resident shareholder at the time the thin capitalization computation is made, i.e., at the end of the taxation year.

In order to be included in the determination of the monthly average under s. (a)(ii) of the “equity amount” definition, the contributions must also have been contributed by a specified non-resident shareholder at the beginning of the month for which an amount is so determined.

Q.2 - Shared workspaces as PEs

Shared workspaces are becoming more and more popular. In the following examples, will a shared workspace in Canada used by a person that is a non-resident of Canada that is resident of the U.S. and carrying on business in Canada, be considered to be a permanent establishment (“PE”) of the U.S. resident person in Canada, assuming Articles V(5) and V(9) of the Canada-US Tax Convention (the “US Treaty”) do not apply?

  1. A U.S. resident consultant has a Canadian membership in the workspace and works from a shared workspace in Canada from time to time, providing services and doing sales calls to Canadian clients.
  2. Rather than open a branch office, a U.S. resident corporation pays for a shared workspace in Canada for use by its Canadian resident employees.

Summary of Preliminary Response

Per ITTN No. 33, the three key factors for PE analysis are:

  1. There must be a place of business.
  2. The place of business must be fixed.
  3. The non-resident must be carrying on his business wholly or partly through this fixed place of business

There is no requirement that a place be owned or rented in order to constitute a PE as long as there is a certain amount of space that is at the disposal of the non-resident.

Shared workspaces come in all shapes and forms, e.g., just a desk, a common area, a conference room, a private office, an entire headquarters, or mail services only. Given the variety of potential arrangements, the above two examples will be focused on.

Example 1

The US resident carries on his services business in Canada from a shared workspace on a regular basis. The consultant is likely considered to have a PE in Canada.

Example 2

The fact that another entity owns the shared workspace is not important to the PE analysis – it is enough that the shared workspace is at the non-resident’s disposal. The premises are a fixed location of business in which business is carried on, and would therefore be a PE.

Q.3 – Participating interest and the Canada-U.S. Convention

A recent CRA advance tax ruling (2016-0664041R3) considered a debt which included both periodic non-participating interest payments, as well as the possibility of future additional payments (the “Additional Amount(s)”) that were contingent on the index price of a particular commodity.

The CRA ruled that the payments of periodic non-participating interest would not be considered to be “participating debt interest” if, at or before the time of such payment, no Additional Amount had been paid or become payable.

However, all payments of periodic non-participating interest would be considered to be “participating debt interest” subject to withholding tax once an Additional Amount is paid or becomes payable.

The rationale appears to be based on the definition of “participating debt interest” in the Act which is: “interest... that is paid or payable on an obligation... all or any portion of which interest is contingent or dependent...”

All interest payments would then be considered to be “participating debt interest” as of the time a contingent or dependent amount is paid or payable.

Under the US Treaty, however, interest paid by a resident of Canada to a resident of the United States that is entitled to the benefits of the US Treaty is not subject to Canadian withholding tax, other than interest:

arising in Canada that is determined with reference to receipts, sales, income, profits or other cash flow of the debtor (…), to any change in the value of any property of the debtor (…) or to any dividend, partnership distribution or similar payment made by the debtor ...”

The US Treaty provision does not include the “all or any portion” language included in the definition of “participating debt interest” in the Act. Would the payments of periodic non-participating interest made after the payment of an Additional Amount be relieved from Part XIII withholding tax under the US Treaty?

Summary of Preliminary Response

The position in the ruling was that each periodic payment of non-participating interest will be participating debt interest subject to Part XIII tax if, at the same time, an additional amount becomes paid or is payable. However US residents may generally be exempted from Part XIII tax by virtue of Art. XI(1) if the interest is not contingent interest under Art. XI(6)(b).

Whether an interest amount is subject to Art. XI(6)(b) is determined for each amount of interest that is paid or credited. The fact that an amount of interest previously paid was subject to Art. XI(6)(b) does not, by itself, mean that all future interest payments will be subject to Art. XI(6)(b).

Q.4 - S. 78 thin cap effect

The thin capitalization rules apply to “outstanding debts to specified non-residents”, which are generally debts or other obligations to pay an amount to certain non-resident creditors, on which deductible interest is paid or payable. Where a debt bears only simple interest, any accrued and unpaid simple interest itself will not be considered to be an outstanding debt to a specified non-resident. Even where the simple interest bears compound interest, that simple interest will not be considered to be an outstanding debt to a specified non-resident until the compound interest is paid and is therefore deductible in accordance with paragraph 20(1)(d) of the Act. See 2016-0626841E5.

In general terms, if the accrued and unpaid simple interest is owing to a non-arm’s length creditor, that interest is unpaid at the end of the second taxation year following the taxation year in which the interest was incurred, and an agreement is filed under paragraph 78(1)(b) of the Act, the accrued and unpaid interest is deemed to have been paid to the creditor, and the creditor is deemed to have made a loan back to the debtor on the first day of the third taxation year. The Act does not, however, set out the terms of this deemed loan.

For purposes of the following questions and responses, assume that no tax is required to be deducted or withheld on the deemed payment of the accrued simple interest.

  1. Assuming compound interest does not accrue on unpaid simple interest and subparagraph 78(1)(b)(ii) deems the amount of that simple interest to be a loan, is that deemed loan considered to be included in “outstanding debts to specified non-residents” as defined in subsection 18(5) of the Act?
  2. Where compound interest does accrue on unpaid simple interest and subparagraph 78(1)(b)(ii) deems the amount of that simple interest to be a loan, is that deemed loan considered to be an outstanding debt to a specified non-resident only when the compound interest has been paid?

Summary of Preliminary Response - Part a

No.

Summary of Preliminary Response - Part b

Generally, where s. 78(1)(b)(ii) deems simple interest to be a loan, the amount of the deemed loan would not be considered to be outstanding debt to a specified non-resident for the purposes of ss. 18(4) and (5) until the compound interest is paid and becomes deductible under s. 20(1)(d).

Q.5 - FX gain on Cdn$ refund of USD reporter

Consider the following hypothetical facts:

  1. Canco is a corporation resident in Canada for purposes of the Act. For its 2010 and subsequent taxation years, Canco elects under subsection 261(3) of the Act to report its Canadian tax results in its functional currency of US dollars (“USD”).
  2. In 2015, Canco files an amended income tax return in respect of its 2012 taxation year, resulting in a reduction to its taxable income determined in USD for that year.
  3. Consequently, the amount of Canco’s Part I income tax payable for its 2012 taxation year is reduced. In accordance with subsection 261(11) of the Act, Canco’s income tax payable, as initially determined in USD, must be converted to Canadian dollars (“CAD”) to determine Canco’s income taxes payable for its 2012 taxation year. As the amount of income tax payable by Canco under the amended return is lower than the amount of income tax actually paid by Canco, the amended return results in an overpayment of income taxes for Canco’s 2012 taxation year.
  4. On October 1, 2015, the amount of income tax overpaid is refunded to Canco. The amount of the overpayment, if it were converted to USD using the exchange rate as of the date of the refund, is greater than the USD amount that would be determined by converting the overpayment to USD using the exchange rate(s) that were initially used in determining Canco’s income tax payable for its 2012 taxation year.

Does the fluctuation between the exchange rates initially used to determine Canco’s 2012 income taxes payable and the exchange rate at the time of Canco’s refund give rise to a gain that will be included in Canco’s income under the Act?

Summary of Preliminary Response

Where a taxpayer who is not a functional currency reporter pays taxes in another jurisdiction in a foreign currency, and receives a refund, Folio S5-F2-C1 states:

...any difference between this figure and the Canadian dollar value of a refund of the overpayment, computed as of the day of its receipt, will be a gain or loss on exchange to which the rules in subsections 39(1) to (2.1) will apply.

Here, Canco, as a functional currency reporter, would be subject to s. 261(5)(a), which provides for its computing its Canadian tax results in the elected currency. When determining the amount of the payment, it must then convert to Canadian dollars, as per s. 261(11).

A functional currency reporter’s foreign-exchange risk arising from an overpayment of Canadian income tax is comparable to a Canadian resident’s foreign-exchange risk arising from the overpayment of tax to a foreign jurisdiction. S. 39 would apply to the gain or loss. Therefore, s. 39 would apply to the foreign-exchange gain or loss that a functional currency reporter might realize.

Q.6 - Return filing obligation of non-resident partners

In general terms, where a non-resident of Canada disposes of property that is “taxable Canadian property” but not “treaty-protected property”, that non-resident is required to apply for a section 116 certificate. In order to obtain this certificate, an amount on account of Part I tax payable must be paid.

Section 150 of the Act then requires that the non-resident must file a Canadian tax return unless certain exceptions apply, one of which refers to a disposition that is an “excluded disposition” as defined in subsection 150(5).

Often the disposition involves numerous non-resident partners and this tax return filing obligation is an obligation of each non-resident partner. This is administratively onerous.

Can the CRA confirm that, in respect of a disposition where a section 116 certificate is issued and all Canadian taxes owing on the resulting taxable capital gain have been paid, no Part I tax is considered to be payable by the non-residents for the purposes of paragraph 150(5)(b), such that the disposition will be an “excluded disposition”?

Summary of Preliminary Response

Non-resident taxpayers are required under s. 150 to file a Canadian tax return if inter alia Part 1 “tax is payable” for the year, being the amount payable before deducting any amounts paid on account of tax, such as instalments or withholding. This interpretation applies to “tax is payable” in ss. 150(1), 150(1.1), and (respecting the definition of “excluded disposition”) 150(5)(b). Therefore, even if a s. 116 certificate has been issued indicating that all Part 1 tax has been paid, there would be no excluded disposition.

Q.7 – S. 246(1)(a) benefit to non-resident

Would the CRA apply paragraph 246(1)(a) of the Act to include in a non-resident’s taxable income earned in Canada an amount of an indirect benefit from a non-resident, where the benefit is not from one of the three Canadian income sources described in subsection 2(3) of the Act, being employment in Canada, carrying on business in Canada and dispositions of taxable Canadian property?

More specifically, consider a scenario where an amount of an indirect benefit would be included in computing a non-resident taxpayer’s income under subsection 15(1) of the Act if the amount of the benefit were a payment made directly to the non-resident taxpayer and if the non-resident taxpayer were resident in Canada.

In that scenario, would the CRA interpret paragraph 246(1)(a) of the Act as including such a shareholder’s benefit in that non-resident taxpayer’s taxable income earned in Canada, even though the benefit is akin to income from property rather than any of the Canadian income sources described in subsection 2(3) of the Act?

Summary of Preliminary Response

Generally, a non-resident’s Part I tax liability, including from any s. 246(1)(a) benefit, is based on the non-resident’s taxable income earned in Canada under s. 2(3) and Division D (ss. 115-116). To the extent that only s. 15(1) is relevant in the analysis of the s. 246(1)(a) benefit being conferred, such a benefit generally would not be considered taxable income earned in Canada, as it would generally not be included under s. 2(3) or Division D.

Even if the benefit amount were not taxable income earned in Canada, it could still be relevant for certain purposes in computing the non-resident’s income, as provided in s. 250.1(1)(b).

Q.8 – Active trade or business of 3rd-country FA (Art. XXIX-A(3))

Paragraph 3 of Article XXIX-A (the “LOB Clause”) of the US Treaty generally provides that a U.S. resident, that is not a qualifying person under paragraph 2 of the LOB Clause and that is engaged in the active conduct of a trade or business in the U.S., can claim treaty benefits with respect to items of income that are derived from Canada in connection with or incidental to that trade or business, provided a number of other conditions are met.

In a situation where a corporation resident in Canada (“Canco”) pays a dividend to its U.S. resident parent corporation (“USco”), would paragraph 3 of the LOB Clause apply in connection with the dividend paid to USco if such income is indirectly derived through the business of Canco’s foreign affiliate (“FA”) that is a resident in a third country?

More specifically, would the requirements of paragraph 3 of the LOB Clause be met in the following hypothetical scenario:

  1. Canco pays a dividend to USco;
  2. USco is owned by non-resident individuals that are residents in a non-treaty country;
  3. USco is a corporation formed in the U.S. and is engaged in the active conduct of a trade or business in the U.S.;
  4. Canco does not have any active business operations in Canada; it is used solely as a holding company for FA, which has an active business that is carried on in a third country;
  5. FA is in the same business as USco’s business and FA’s activities are all connected to USco’s business.

Summary of Preliminary Response

Of the three tests set out in Art. XXIX A(3) –

  1. the US is engaged in the active conduct of a trade or business in the U.S.;
  2. the income is “derived from [Canada] in connection with, or incidental to, that trade or business (including any such income derived directly or indirectly by [the U.S. resident] through one or more other [Canadian residents] (the “connected test”); and
  3. the trade or business carried on in the U.S. is substantial in relation to the activity carried on in Canada giving rise to the income in respect of which treaty benefits are claimed -

the connected test will not be satisfied.

To the extent that this denial is not considered appropriate in the circumstances, the taxpayer may request special relief through the CRA competent authority under Art. XXIX-A(6).

Q.9 – Incomplete surplus documentation

A corporation resident in Canada (“Canco”) received a dividend in a taxation year from a wholly-owned foreign affiliate (“FA”).

Canco did not prepare a detailed calculation of its exempt surplus, hybrid surplus and taxable surplus accounts, neither did it make any detailed determination of its hybrid underlying tax and underlying foreign tax accounts in respect of FA as would have been required under Part LIX of the Regulations.

Canco decided to claim a deduction under subsection 113(1) of the Act equal to the amount of the dividend (the “113 Deduction”) based on the application of the general ordering rules of subsections 5900(1) and 5901(1) of the Regulations for the purpose of determining its taxable income for the year.

Should a more careful review result in the amount of the dividend not being completely sheltered by the 113 Deduction, Canco was of the view that the adjusted cost base (“ACB”) of the FA shares was sufficient to prevent any further net inclusion to its taxable income for the year that might otherwise have resulted from the interplay of paragraph 53(2)(b), subsection 40(3) and subsection 92(2) of the Act.

  1. What information should Canco maintain with respect to the 113 Deduction in respect of the dividend paid by a FA in a taxation year? Are detailed surplus account computations essential to support the 113 Deduction?
  2. Would the CRA accept the late filing by Canco of an election under subsections 5901(2.1) and (2.2) of the Regulations (“PAS Election”) in order for the dividend to be completely sheltered by the 113 Deduction?

Summary of Preliminary Response - Part a

Surplus account calculations are required to substantiate s. 113(1) claims, and those balances are also relevant to other provisions, such as ss. 55(5)(d), 90(9), 40(3), and 93(1.1). As the tax system relies on self-reporting, taxpayers must take care in determining the amount of the dividend deductible under s. 113(1), and allocations under the Regulations. Their records must also support those deductions (s. 230(1)).

If a complete surplus computation is not provided to the CRA, its current general practice is to deny the deduction under s. 113(1).

In addition, taxpayers are responsible for conducting their affairs in a reasonable manner. In that respect, s. 230(1) specifically requires taxpayers to retain records and books of account in such form, and containing such information, as will enable the determination of taxes payable under the Act. Pursuant to 231.1(1)(a), the taxpayer’s books and records can also be examined by an authorized CRA person. An unsupported s. 113(1) claim could be subject inter alia to ss. 152(4), 163(2), 163(2.2) or 239(1), depending on the circumstances.

Summary of Preliminary Response - Part b

If the Reg. 5901(2.1) conditions are met, Reg. 5901(2.2) accords the discretion for elections made after the Reg. 5901(2)(b)(i) filing deadline to be deemed to have been timely filed.

The Reg. 5901(2.1)(a) and (b) conditions are that the corporation must demonstrate that it determined using reasonable efforts to not make an acquisition surplus election in respect of the whole dividend before the filing due-date. CRA’s view is that relying on surplus balances to support the deduction under s. 113(1) without having made a detailed computation, would generally not meet the conditions for that provision to apply.

In the situation submitted, the determination not to make an election will generally not be considered to have been made using reasonable efforts. In addition, Reg. 5901(2.2) provides that the Minister must determine that it would be “just and equitable” to permit a late filing of the election. The Finance Explanatory Notes state:

The taxpayer must make reasonable efforts not to file the election in the first place. It is expected to have adequately documented those efforts at the time of that determination – i.e. before the normal deadline for filing the election.

In our view, it would not be just and equitable to permit the filing of a late election where Canco did not make detailed calculations of its relevant surplus accounts on the assumption that the late election, and related ACB deduction, would result in no income inclusion.

Q.10 - Foreign affiliate earnings and foreign transfer pricing adjustments

Consider the following scenario:

  1. Parent, a corporation formed and resident in Canada, is the parent company of a global business operation.
  2. Parent wholly owns a corporation formed and resident in Canada (“Canco”) and a corporation formed and resident in Country A (“CFA”), a designated treaty country as defined in subsection 5907(11) of the Regulations.
  3. Parent and CFA entered into an agreement whereby CFA provided services to certain companies directly or indirectly held by Parent (the “CFA Service Agreement”).
  4. The income earned by CFA was income from an active business carried on in Country A and not foreign accrual property income (“FAPI”) as defined in subsection 95(1) of the Act.
  5. Parent also entered into an agreement with Canco whereby Canco provided services to certain companies directly or indirectly held by Parent (the “Canco Service Agreement”).
  6. The CRA subsequently issued tax reassessments to Canco for certain taxation years, including in the income of Canco under the Canco Service Agreement a portion of the fees received by CFA under the CFA Service Agreement.
  7. Canco and CFA submitted a request to the Competent Authorities of Canada and Country A under the Mutual Agreement Procedure (“MAP”) of the Canada-Country A Tax treaty for relief from double-taxation with respect to the reassessed taxation years.
  8. The adjustments under the MAP settlement resulted in reassessments by the Country A tax authority to reduce CFA’s income in each relevant taxation year and in a repayment to CFA of the amount of Country A income taxes that were paid but were not due in light of the adjustments under the MAP Settlement.
  9. Moreover, pursuant to the MAP Settlement, it was agreed that no secondary adjustment would be made: i) to the income of Canco or CFA; or ii) to create a loan, deemed trust or other obligation between Canco and CFA.
  10. CFA did not and will not make any payment to Canco in respect of the addition to the income of Canco for Canadian tax purposes pursuant to the reassessments.
  11. Under Country A law, transfer pricing adjustments and corresponding reassessments by the Country A tax authority do not alter the legal right of CFA to the income it earned pursuant to the CFA Service Agreement and do not result in a recharacterization of the nature of the income earned by CFA.
  12. Moreover, Country A accounting standards do not require any restatement of CFA’s original financial statements with respect to the relevant taxation years in connection with the adjustment to CFA’s income under Country A’s tax law.

As a result of the reassessment of the taxable income of CFA in Country A and the corresponding refund of income taxes payable of CFA:

  1. Would there be a re-computation of earnings and net earnings of CFA for the relevant taxation years under subsection 5907(1) of the Regulations?
  2. Would there be an addition to the earnings of CFA under paragraph 5907(2)(f) of the Regulations for the relevant taxation years of the amount of the income retained but excluded from its income for Country A income tax purposes?

Summary of Preliminary Response

Pursuant to the MAP settlement, Country A reassessed CFA to reduce its income for each taxation year, resulting in a repayment to CFA of the Country A income taxes previously paid. CRA was satisfied that Country A’s domestic legislation itself provided for in income adjustment in those circumstances, thereby causing a reduction in “earnings” under Reg. 5907(1), which term is defined by reference to the “income tax law” of Country A.

There are some further adjustments in this scenario. There would be an addition to earnings under Reg. 5907(2)(f) because that amount that was excluded for Country A purposes but still retained by CFA under the terms of the settlement, which did not provide for repayment of the excess income received by CFA. There was an increase under Reg. 5907(1) on account of taxes that were paid but not due as a result of their adjustment and refund.