INBOUND FINANCING AND INVESTMENTS
2012 MINING TAXATION UPDATE
ACUMEN INFORMATION
MAY 10, 2012
Steve Suarez
Borden Ladner Gervais (Toronto)
OVERVIEW OF PRESENTATION
1.
Financing & Inbound Investment
• Debt Financing
• Equity Financing
• Alternative Investments
• Non-Resident Acquisitions of Canadian Mining Companies
2.
Exit Strategies
• Taxable Canadian property
• Tax treaty protection
• s.116 issues
3.
Cross-Border Canada – U.S. Issues
• Limitation on benefits under the Canada-U.S. Treaty
• Using hybrid entities in inbound transactions
2
Financing & Inbound Investment
Non-residents making Canadian mining investments (new projects
in Canada, acquiring interests in existing projects or acquiring
interests in existing Canadian entities) must consider:
•
•
•
•
•
Canadian income tax
Canadian withholding tax
home-county taxes
limited legal liability
day-to-day functionality
In most cases other than straightforward lending or royalties, this
will involve using a Canadian corporation (directly or indirectly) as
the investment vehicle
3
Financing & Inbound Investment
Debt Financing: non-residents have a number of important
considerations to balance
• where to locate interest expense
• thin capitalization limitations on Canadian interest deductibility
• possibilities for double-dip financing
• Canadian interest withholding tax
• Other considerations
4
Financing & Inbound Investment: Debt
On simple loans to arm’s length borrowers, a non-resident will typically
be worried only about home country taxation of interest income
•
no Canadian withholding tax on interest paid to a non-resident
creditor dealing at arm’s length with Canadian borrower, unless
interest is “participating” (e.g., variable based on profit, cash flow,
etc.)
Otherwise, if non-resident is debt-financing a Canadian investment, need
to consider whether
•
interest expense deductions are most useful in Canada or the nonresident’s home country (effective tax rate, where sufficient taxable
income exists, etc.);
•
withholding tax costs of lending to Canada; and
•
is there any scope for multiple deductions?
5
Financing & Inbound Investment: Debt
Thin capitalization restrictions (s.18(4)ITA)
Canadian corporations are restricted on the amount of interest expense
they can deduct on debt owing to “specified non-residents”: nonresidents who own, or deal non-arm’s length with someone who owns,
25%+ of Canco’s equity (by votes or value)
No interest deduction on debt owing by Canco to specified non-residents,
to the extent it exceeds 2x Canco’s “equity”, being the sum of
•
Canco’s start-of year unconsolidated retained earnings;
•
Canco’s contributed surplus received from specified non-resident
shareholders; and
•
paid-up capital of Canco shares owned by specified non-resident
shareholders
6
Financing & Inbound Investment: Debt
Thin capitalization restrictions are being tightened under the
March 2012 federal budget
•
•
•
debt/equity limit being reduced to 1.5:1 (effective 2013)
rules now capture debt of partnerships that have Canadian
corporations as partners
disallowed interest expense with be treated as a dividend (not
interest) for withholding tax purposes
See “Canadian 2012 Federal Budget: Tightening the Screws,”
included with materials
7
Financing & Inbound Investment: Debt
Foreign Parent
Foreign
Finance Co
$50M equity
$100M
loan
Canco
Starting in 2013, Canco can only deduct interest on $75M of the debt
owing to Foreign Finance Co
• no deduction for interest on the remaining $25M, which is treated
as a dividend and subject to dividend withholding tax
8
Financing & Inbound Investment: Debt
Double-Dip Structures
Where U.S. parent is lending to Canadian subsidiary,
consider whether a “double dip” hybrid structure can
be used to create an instrument that is debt for
Canadian purposes (deductible interest expense for
Canco) but equity for U.S. purposes (no interest
income for U.S. parent)
9
Financing & Inbound Investment: Debt
US Co
3. Support
Agreement
Third-party debt
1. Loan
4. Guarantee
2. Forward Subscription
Agreement
LLC
Canco
Summary
1.
2.
3.
4.
10
US Co uses proceeds of 3rd party debt to make a loan to Canco
Simultaneously, LLC enters into a forward subscription agreement with Canco to
purchase Canco shares for cash equal to the principal amount of the loan on the
maturity date
Simultaneously, US Co enters into a support agreement with LLC to purchase shares
for cash in order that LLC can fund its obligation under the forward subscription
agreement
Simultaneously US Co provides Canco with a guarantee of LLC’s performance under
the FSA
Financing & Inbound Investment: Debt
US Co
3. Support
Agreement
4. Guarantee
1. Loan
LLC
2. Forward Subscription
Agreement
Canco
Summary
1.
2.
3.
4.
11
Loan from US Co to Canco
Forward subscription agreement between LLC and Canco
Support agreement between US Co and LLC
Guarantee from US Co to Canco
Financing & Inbound Investment: Debt
Interest Withholding Tax
Under Part XIII, Canada no longer levies withholding tax on interest (other
than participating interest) paid to a creditor dealing at arm’s length with
the debtor
“participating debt interest” means interest (other than interest
described in any of paragraphs (b) to (d) of the definition “fully exempt
interest”) that is paid or payable on an obligation, other than a prescribed
obligation, all or any portion of which interest is contingent or dependent
on the use of or production from property in Canada or is computed by
reference to revenue, profit, cash flow, commodity price or any other
similar criterion or by reference to dividends paid or payable to
shareholders of any class of shares of the capital stock of a corporation.
12
Financing & Inbound Investment: Debt
Interest Withholding Tax: other relevant provisions
s.214(6): deemed payment of accrued interest on transfer of
bond, etc. by a non-resident to a Canadian resident, if bond issued
by Canadian resident
s.214(7): deemed payment of interest on transfer of bond, etc. by
a non-resident to a Canadian resident, if issued by Canadian
resident and transfer price exceeds issue price of the bond
s.214(8): “excluded obligations”, carved out of s.214(7) and
partially carved out of s. 214(6) (former 5/25 debt or shallow
discount debt issued for not less than 97% of principal amount)
13
Financing & Inbound Investment: Debt
Interest Withholding Tax: convertible debentures
There is considerable uncertainty as to the tax treatment of
holders of convertible debentures who are non-residents
• not clear whether the value of shares received on conversion
over principal amount is “participating interest” (if so
Canadian withholding tax applies on sale or conversion of
debenture)
• not clear whether “regular” interest is tainted by the
conversion premium
CRA administrative position has been “under development” for
almost 4 years, and remains in progress
14
Financing & Inbound Investment: Debt
Interest Withholding Tax: Tax treaty structuring
While most of Canada’s tax treaties reduce the 25% rate of Part XIII
interest withholding tax to 10%, the rate under the Canada-U.S. Treaty for
U.S. residents entitled to Treaty benefits is 0%, even if dealing non-arm’s
length with the debtor
➙ This creates an incentive for non-residents outside the U.S. to
consider financing into Canada through a U.S. group member, in
order to get 0% interest withholding
Issues to watch for
•
limitation on benefits under the Canada-U.S. Treaty
•
anti-hybrid rules in Canada-U.S. Treaty
•
anti-avoidance mechanisms (discussed below)
15
Financing & Inbound Investment: Debt
Interest Withholding Tax: Financing Through the U.S.
Foreign
Parent
Foreign
Parent
Debt
(10% w/h tax)
U.S. Financeco
Debt
(0% w/h tax rate)
Canco
16
Canco
Financing & Inbound Investment: Debt
s.78: Accrued and Unpaid Interest:
Deductible amounts owing to a non-arm’s length person and which
remain unpaid at the end of the second taxation year following the year it
was incurred, are added back to income in the third following year, unless
the parties jointly elect to deem the amount to have been paid
Figure 1. Accrued Non-Arm’s-Length Interest and Section 78(1)
12/31/08
12/31/09
Interest accrues
for 2009
17
12/31/10
12/31/11
Payment deadline
for 2009 interest
12/31/12
12/31/13
Deemed-payment
election deadline
Financing & Inbound Investment: Debt
Foreign Exchange Issues
When lending into Canada, consider the F/X implications of the loan
•
•
•
Canadian debtor borrowing non-Cdn. $ will realize income/gain/loss
on maturity, with any loss probably denied recognition if incurred on
debt from a non-arm’s length lender
Canadian debtor should not assume any gain will be a capital gain:
need to consider capital/income treatment
Canco may want to consider making the s.261 foreign currency
election in appropriate circumstances
For more on the tax treatment of F/X gains and losses, see “Canadian
Taxation of Foreign Exchange Gains and Losses” at
www.miningtaxcanada/about/
18
Financing & Inbound Investment: Equity
Equity Financing: principal Canadian tax considerations for
non-residents making an equity investment in Canada:
•
tax recognition of cost of investment
•
maximizing cross-border paid-up capital (PUC)
•
minimizing Canadian dividend withholding tax
•
minimizing Canadian taxation of gains on exit
•
managing s.116 obligations on sale
19
Financing & Inbound Investment: Equity
Paid-up Capital
• Tax equivalent of corporate law share capital
• Basic concept is that shareholders should be able to extract
PUC without being treated as receiving a dividend (but reduces
shareholder’s cost in the share)
• Each share of the same class or series has the same PUC (PUC
of class divided by # of shares)
20
Financing & Inbound Investment: Equity
Paid-up Capital: pooled within each class
After
Before
X
Y
FMV = $200
Cost/PUC = $100
Y
X
Cost/FMV = $200
PUC = $150
$200
CanCo
CanCo
$200
21
FMV = $200
Cost = $100
PUC = $150
Financing & Inbound Investment: Equity
Paid-up Capital: non-residents
Especially important for non-resident purchasers
•
PUC can be extracted out of Canada without dividend withholding tax
•
PUC increases how much debt Canco can incur from related nonresidents on an interest-deductible basis
•
2012 federal budget targets PUC increases where foreign-controlled
Canco makes an “investment” in a foreign affiliate that does not
satisfy a business purpose test (see “Canadian 2012 Federal Budget:
Tightening the Screws”)
22
Financing & Inbound Investment: Equity
Paid-up Capital: non-resident acquisition
Non-Resident
Buyer
Vendor
FMV = $10M
PUC = $2M
$10M
Canco
23
Financing & Inbound Investment: Equity
Incorrect
Non-Resident
Buyer
Correct
Vendor
Non-Resident
Buyer
$10M
FMV/Cost = $10M
PUC = $2M
$10M
FMV/Cost/PUC = $10M
New Canco
Canco
FMV/Cost = $10M
PUC = $2M
Canco
24
Vendor
Financing & Inbound Investment: Equity
Equity Distributions
A Canadian corporation can choose to make a distribution to
shareholders either as (1) a dividend, or (2) a return of capital (to the
extent of the stated capital of its shares)
•
unlike the U.S., there is no rule treating all distributions as dividends
for tax purposes to the extent the corporation has earnings & profits
(E & P)
A dividend triggers dividend withholding tax but does not reduce the
holder’s basis in the share
A return of capital reduces basis in the share and is not treated as a
dividend to the extent of PUC (except where s.84(4.1) applies)
25
Financing & Inbound Investment: Equity
Equity Distributions
In a mining investment, the prospect of dividends is often remote
unless the Canadian corporation is a producer of significant size
(mining is very capital-intensive)
•
dividend-paying mining corporations tend to be large public
companies, which are severely limited in their ability to make
capital reductions for tax purposes due to s.84(4.1)
As a result, choice of jurisdiction to hold Canadian mining shares
is usually driven by (1) recipient-country taxation, and (2)
managing Canadian taxation of gains on dispositions, (see Exit
Strategies)
26
Financing & Inbound Investment: Periodic Repatriations
Dividend
PUC
from Canco Reduction
from Canco
Loan from Canco
Withholding
Tax
25%; potentially
reduced as low as
5% by tax treaty
(note Canada-U.S.
problem
with
ULCs)
None if sufficient PUC;
reduces holder’s basis in
shares of payer
None if repaid within permitted timeframe and not
part of a series of loans and repayments; otherwise
treated as a dividend
Comments
Consider whether
relevant Canadian
corporate
law
places
any
constraints
on
Canco’s ability to
declare and pay
dividend
(e.g.,
solvency test)
No U.S. style E&P rule;
can choose to reduce
PUC even if profits exist
(subject to s.84(4.1) for
public corporations)
Consider effect on thin
capitalization rules to
Canco
Various rules require market interest rate to be
charged by Canadian lender
27
Financing & Inbound Investment: Royalties
It is relatively unusual for foreigners to invest in a Canadian
mining project in the form of a royalty, as these tend to be taxinefficient
•
effectively no cost recognition for Canadian purposes, as
CDE pool rarely of use to a non-resident
•
royalties subject to 25% withholding tax under Part XIII
•
Canada’s tax treaties tend to offer little or no relief from
Canadian taxation of Canadian-source mining royalties
28
Financing & Inbound Investment: Metal Streams
Metal stream transactions are a particular form of mining
transaction that typically sees a producer sell secondary output
(e.g., silver from a gold mine) to an arm’s length purchaser,
usually on the basis of an upfront payment plus a relatively low
price per unit delivered (considerably less than spot)
•
structured so as not to be a royalty
•
up-front payment often set up as a deposit
While possible to effect directly into Canada, (especially where the
mine is located in Canada) metal stream transactions are typically
set up with a foreign subsidiary of the Canadian mining company
29
Financing & Inbound Investment: Metal Streams
Vendor
Purchaser
Mine
Spot
Contract
Forward
Contract
Vendor
Subco
Vendor sells output to vendor Subco at spot
Vendor Subco sells output to Purchaser at
lesser of spot and Kn price, with an upfront
payment
30
Income Tax Results:
• Vendor: payments from
Vendor Subco included in
income when received
• Vendor Subco: upfront
payment included into
income when received; s.
12(1)(m) reserve claimed for
goods to be delivered in
future. Sales income from
Purchaser included into
income as received.
Financing & Inbound Investment: Acquisitions
Acquisitions of Canadian mining companies: see B.
Sinclair’s presentation
•
•
•
•
•
31
form of transaction
form and amount of consideration
process
structuring considerations
purchaser (s.116 issues, s.88(1)(d) bump, exit strategy)
vendor (tax minimization, deferral, s.116 issues)
pre-and-post transaction planning
Financing & Inbound Investment: Acquisitions
Points of particular relevance to non-resident purchasers
•
maximizing cross-border PUC (to maximize Canadian interest
deductibility under thin capitalization rules and the ability to effect
distributions as PUC returns)
•
s.88(1)(d) bump
• limited to using cash consideration
• especially useful to extract Target’s foreign subsidiaries out of Canada
•
limited ability to offer tax deferral to Target shareholders who are taxable in
Canada on gains (unless using exchangeable shares)
•
special considerations when planning for sale of investment (minimizing
Canadian tax on gains)
32
Financing & Inbound Investment: Acquisitions
Illustration of Inbound Acquisition Planning
Pre-Acquisition
Shareholders
Foreign Parent
FMV = $300
PUC = $80
$180
debt
Equity
FMV/PUC/
Cost = $120
Canada
Canco
Bidco
FMV = $210
Cost = $85
FMV = $90
CCDE/CCEE = $45
Foreign
Subsidiary
Canadian
Mine
$300
Foreign
Mine
33
Financing & Inbound Investment: Acquisitions
Post-Acquisition
Foreign Parent
Foreign lender/shareholder
located in appropriate tax
Treaty country regarding
Interest/dividends/gains
Use of foreign holdco
provides flexibility on
sale
Foreign Holdco
Equity
FMV/PUC/
Cost = $120
Bidco debt/equity
optimized regarding
thin cap
$180
Debt
Canada
Bidco/Canco merger
consolidates interest
expense with operating
interest income
Cost of bumpEligible property
increased
Planning to use target
losses and manage
successor rules
Bidco
(post-amalgamation)
$300
FMV = $210
Cost = $210
Foreign
Subsidiary
Foreign
Mine
34
Shareholders
FMV = $90
CCDE/CCEE = $45
Foreign
Mine
Consider pre-acquisition
Planning for bump-eligible
property
Financing & Inbound Investment: Acquisitions
For more on acquisitions of Canadian mining corporations see:
•
www.miningtaxcanada.com/mergers-acquisitions/
•
“Using Exchangeable Shares in Inbound Canadian
Transactions” (About page of website)
•
“Canada’s Tax Cost Step-Up: What Foreign Purchasers
Should Know” (About page of website)
•
“Canada’s Section 116 System for Non-Resident Vendors of
Taxable Canadian Property” (included with materials)
35
Exit Strategies
The time to plan for how to exit an investment in Canadian mining
is before making the investment, especially for non-residents.
Careful planning can help minimize:
•
Canadian capital gains tax
•
Canadian s.116 obligations
•
home-country taxation (direct and CFC)
Taxpayers are invariably more successful with planning that is put
in place at the time the investment is made as opposed to
planning done near the time of sale
36
Exit Strategies: Debt
Unless somehow convertible into or exchangeable for another
property, a debt investment into Canada will generally not
constitute “taxable Canadian property” so as to be subject to
Canadian capital gains tax or s.116 obligations
•
simply lending to a Canadian mining company does not create
TCP
But consider the potential for s.214(7) to create Part XIII tax on
sale or redemption if proceeds exceed issue price and debt is not
an “excluded obligation”
37
Exit Strategies: Equity
When making an equity investment in Canada, the three principal
Canadian tax considerations are:
•
will the investment constitute TCP, so as to be subject to
Canadian capital gains tax
•
if so, can protection from Canadian capital gains tax be found
in a relevant tax treaty
•
if the investment constitutes TCP, do the parties have
obligations under the s.116 system governing dispositions of
TCP by non-resident vendors
38
Exit Strategies: Equity
Taxable Canadian Property
•
•
•
•
includes interest in Canadian real property or Canadian resource
property (which includes most mining royalties)
property used or held in a business carried on in Canada
share not listed on a designated stock exchange (other than of a
mutual fund corporation) or partnership interest or trust interest (other
than of a mutual fund trust), that derives its value (directly or
indirectly) primarily from Canadian real/resource properties anytime in
the preceding 60 months (other than through a corporation,
partnership or trust whose shares/interests are not TCP)
share that is listed on a designated stock exchange, or of a mutual
fund corporation, or interest in a mutual fund trust, if at any time in the
preceding 60 months both:
•
•
39
more than 50% of the share’s/interest’s FMV was derived (directly or indirectly/ from
Canadian real/resource properties; and
taxpayer (together with non-arm’s length persons) owned 25%+ of corporation’s shares or
MFT’s units
Exit Strategies: Equity
Summary: TCP Status
Property
TCP Status
Shares of corporations listed on a designated stock exchange;
shares of mutual fund corporations; units of mutual fund
trusts
TCP if at any time during the preceding 60 months, both
1. the nonresident holder owned more than 25 percent of any
class of the corporation’s shares or the trust’s units (including
any shares or units owned by non-arm’s length persons), and
2. more than 50 percent of value of the shares or units was
derived (directly or indirectly) from Canadian real property
Unlisted shares of corporations (other than mutual fund
corporations); interests in partnerships and most trusts
TCP if at any time during the preceding 60 months more than
50 percent of value of the share or interest was derived from
Canadian real property directly or indirectly (otherwise than
through a corporation, partnership or trust the shares or
interests of which are not themselves TCP at that time)
40
Exit Strategies: Equity
Determination of taxable Canadian property status for
shares
2010 Budget narrowed TCP status for shares: only TCP if shares
derive value primarily from Canadian real property in past 5 years
(directly or indirectly)
Previously, CRA had allowed taxpayers to make “value primarily
derived” determination based on (1) corporation’s gross assets,
or (2) corporation’s net assets, allocating liabilities on a
reasonable basis
41
Exit Strategies: Equity
At 2011 CTF Round Table, CRA announced a change in its
administrative policy
1. For property held by the taxpayer any time during 2011 and
disposed of before 2013, old policy applies
2. For all other property, the CRA will make “value primarily
derived” determination based on gross assets
Q: shouldn’t the value of a share be based on the value of the
corporation’s assets less all claims ranking ahead of the shares,
i.e., on a net assets basis?
42
Exit Strategies: Equity
Tax Treaties: where the Canadian equity investment will (or may
in the future) constitute TCP, it is essential to consider whether tax
on sale could be reduced either by
•
structuring the exit as a dividend for Canadian tax purposes (if
dividend withholding tax is less than Canadian capital gains
tax), or
•
using a tax treaty to achieve a more favourable result, taking
into account (1) Canadian taxation of the gain, (2) taxation of
the gain in the shareholder’s jurisdiction, (3) costs of
distributing the sale proceeds out of the shareholder’s
jurisdiction (whenever this occurs) and (4) taxation of that
distribution in the jurisdiction of the ultimate parent
43
Exit Strategies: Equity
Tax Treaties: there is a very wide range of protection from Canadian capital
gains taxation on a sale of shares in Canada’s tax treaties (see “Canadian Taxation
of Mining,” included with materials) – for example:
No relief (e.g., Chile. ,Argentina, Brazil, Australia, Japan, India)
Taxation if share value derived primarily from Canadian real property (e.g., China,
Singapore, Korea, Ireland)
As above, but operating mines excluded from “real property” (e.g., Netherlands,
Germany, South Africa, Luxembourg, Switzerland, U.K.)
Taxation limited to Canadian corporations (Netherlands, Russia, Switzerland, U.S.,
Germany)
Publicly-listed shares excluded (Luxembourg, Netherlands, U.K., Germany,
Switzerland)
Minimum ownership threshold, usually 10% (South Africa, U.K., Netherlands,
Luxembourg, Switzerland)
44
Exit Strategies: Equity
Tax Treaties
Residence:
mind and management is not in jurisdiction of
entity’s governing law
Agency:
entity is acting as agent for someone else
Beneficial Ownership:
entity is not the beneficial owner of the relevant
property
Sham:
purported legal relationships do not in fact exist
Treaty Shopping:
use of treaty jurisdiction somehow inherently
abusive
45
Exit Strategies: Equity
s.116 System: applicable to dispositions of TCP by a nonresident (whether or not any tax is owing or any gain exists),
unless an exception applies; consists of
•
vendor notification obligation
•
purchaser remittance obligation
•
vendor tax return filing obligation
See “Canada’s Section 116 System for Non-Resident Vendors of
Taxable Canadian Property” (included with materials)
46
Exit Strategies: Equity
s.116 System: Excluded Property
Generally no s. 116 system obligations arise to the extent the TCP is “excluded
property,” which includes:
•
shares listed on a recognized stock exchange
•
deemed TCP (e.g., shares received on a tax-deferred rollover)
•
bonds, debentures, mortgages and similar obligations
•
options/interests in respect of the foregoing
•
“treaty-exempt property” (which requires the purchaser to notify the CRA
within 30 days of sale if the purchaser and vendor are related)
47
Exit Strategies: Equity
s.116 System: Vendor notification obligation
Vendor is required to notify the CRA within 10 days of the
disposition, unless the TCP is (1) excluded property, or (2)
property described in s.116(5.2), viz., property that may yield
income on disposition
s.116 System: Vendor Tax Return Obligation
Vendor is required to file a Canadian tax return, unless all TCP
dispositions in the year are (1) of excluded property, or (2) ones in
respect of which the CRA issued a certificate of compliance
48
Exit Strategies: Equity
s.116 System: Purchaser remittance obligation
Purchaser is liable to remit to the CRA (and may withhold from the
purchase price) 25% of the purchase price, unless
•
property is excluded property;
•
purchaser reasonably believes that vendor is not a non-resident, after
making reasonable inquiry;
•
requirements for s.116(5.01) “treaty protected property” exception are
met; or
•
CRA has issued a certificate of compliance
49
Exit Strategies: Equity
s.116 Withholding: Treaty-protected property exception
Where a non-resident vendor is claiming to be exempt from tax on a disposition
of TCP due to a treaty exemption, purchaser can
1. withhold and remit;
2. demand a certificate of compliance; or
3. file Form T2062C within 30 days of sale under s. 116(5.01)
Problem with 3. was that s.116(5.01), which was introduced in 2008, does not
exempt the purchaser from liability if treaty exemption does not in fact apply
(e.g., due to valuation uncertainty, chattel/fixture uncertainty, former residence,
limitation on benefits, anti-avoidance, etc.)
➙ Result: Purchasers often unwilling to rely on 3.
50
Exit Strategies: Equity
s.116 Withholding: Treaty-protected property exception
Statement on CRA website (“Disposing of or acquiring certain
Canadian property”) now provides that CRA will generally not assess a
purchaser for not withholding in good-faith belief that non-resident was
treaty-exempt if
• purchaser has filed Form T2062C;
• purchaser and vendor are unrelated; and
• purchaser has made every reasonable effort to determine that
property is treaty-exempt
“Every reasonable effort” means at least the steps suggested on Form
T2062C
51
Canada-U.S. Treaty Issues: Limitation on Benefits
Canada’s treaty with the U.S. is the only Canadian tax
treaty that contains a comprehensive “limitation on
benefits” (LOB) Article, restricting who may claim
benefits under the Treaty (it is not enough just to be a
U.S. resident)
U.S. subsidiaries of foreign corporations generally do
not qualify under the base test
See “Thoughts on the New LOB Clause in The CanadaU.S. Treaty” (included with materials)
52
Canada-U.S. Treaty Issues: Limitation on Benefits
Limitation on Benefits: Summary of Analysis
Is person
seeking treaty
benefits a
U.S. resident
for treaty
purposes?
No
Not eligible for
treaty benefits.
Yes
Is U.S.
resident a
qualifying
person?
No
Yes
Eligible for
treaty
benefits.*
* Availability of treaty benefits subject to antiabuse rules as per Article XXIX-A (7).
53
Are benefits
available under
“active trade or
business
exception”?
Yes
Eligible for
treaty
benefits.*
No
Treaty benefits
available only if
“derivative benefits”
test met (limited
benefits only) or under
residual exception in
Article XXIX-A(6).*
Canada-U.S. Treaty Issues: Limitation on Benefits
Basic test: is the U.S. resident claiming Treaty benefits a “qualifying
person”?
1.
natural person
2.
corporation whose principal class of shares primarily traded on
recognized Canadian or U.S. stock exchange
3.
corporation more than 50% of whose shares (by votes and value) are
owned by 5 or fewer persons described in 2 (directly or indirectly
through a chain of qualifying persons)
4.
corporation 50% or more of whose shares (by votes and value)
are not owned (directly or indirectly) by non-qualifying persons
54
Canada-U.S. Treaty Issues: Limitation on Benefits
Active Trade or Business (ATB) Test Summary
Is person
seeking
treaty
benefits a
U.S.
resident for
treaty
purposes?
Yes
Is the U.S.
resident (or
related
person)
actively
conducting
a trade or
business in
the U.S.
(other than
an ineligible
business)?*
Yes
Is the U.S. trade
or business
Yes
substantial
relative to the
activity carried
on in Canada
giving rise to the
income on which
the U.S. resident
is seeking treaty
benefits?
Is the Canadiansource income
derived in
connection with or
incidental to the
U.S. trade or
business (directly
or indirectly
through one or
more Canadian
residents)?
No
No
Active trade or
business
exception not
available.
Active trade or
business
exception not
available.
No
Active trade or
business
exception not
available.
No
Active trade or
business
exception not
available.
* An ineligible business is the making or managing of investments, unless carried on with customers in the ordinary course
of business by a bank, insurance company, registered securities dealer, or deposit-taking financial institutions.
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Yes
U.S. resident
entitled to
treaty benefits
with respect
to connected
or incidental
income,
subject to
antiabuse
limitations.
Canada-U.S. Treaty Issues: Limitation on Benefits
Derivative Benefits Test Summary
Is person
seeking
treaty
benefits a
U.S.
resident for
treaty
purposes?
Yes
No
Are 90% + of
U.S. company’s
shares* owned,
directly or
indirectly, by
qualifying
persons or
eligible thirdcountry
shareholders?**
Yes
Are U.S.
company’s eligible
third-country
shareholders
entitled to
Canadian tax rate
on the relevant
income as low or
lower than the
corresponding
rate under the
treaty?
No
Yes
Does U.S.
company meet
base erosion
test (deductible
expenses
payable to
non-qualifying
persons < 50%
of gross
income)?
No
No
Not eligible for
derivative benefits.
Not eligible for
derivative benefits.
Not eligible for
derivative benefits.
Not eligible for
derivative benefits.
•“Debt substitute shares” are ignored under this test, and a further test applies if a “disproportionate class of shares” exists.
** An eligible third-country shareholder is a resident of a third country entitled to full benefits under a treaty between Canada
and that third country, and who (if resident in the U.S.) would either be a qualifying person under the Canada–U.S. treaty or
eligible for treaty benefits under the “active trade or business” test (if it was assumed that the shareholder carried on in the
U.S. the same business it in fact carries on in the third country).
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Yes
U.S. company
entitled to
treaty benefits
under Articles
X (Dividends),
XI (Interest),
and XII
(Royalties),
subject to
antiabuse
limitations.
Canada-U.S. Treaty Issues: LLCs
For many years, Canada refused to extend Treaty benefits to LLCs
that are disregarded for U.S. tax purposes, on the basis that they
were not U.S. residents (liable to pay tax in the U.S.), and would
not look through them (like partnerships) to allow the LLC
members to claim Treaty benefits
CRA continued this position in spite of Tax Court decision in TD
Securities LLC v. The Queen holding the taxpayer LLC to be
entitled to Treaty benefits
Article IV(6) (added by the 2007 Protocol) addresses this, by
allowing Treaty benefits to be claimed by U.S. residents (only) on
items of income earned through a disregarded LLC
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Canada-U.S. Treaty Issues: Anti-Hybrid Rules
Unlimited Liability Corporations (ULCs): popular with U.S.
companies investing in Canada, because they can elect to
disregard the ULC for U.S. tax purposes
Under Article IV(7)(b) of the Canada-U.S. Tax Treaty, Treaty
benefits are denied where U.S. taxation is different as a result of
the ULC being disregarded for U.S. tax purposes
➙ 25% Canadian withholding tax instead of 0% (interest) or 5% (dividends)
➙ especially problematic on payments from ULC to LLC
There are work-arounds, but use disregarded ULCs with caution
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Canada-U.S. Treaty Issues: Anti-Hybrid Rules
Article IV(7)(b)
An amount of income, profit or gain shall be considered not to be paid to or
derived by a person who is a resident of a Contracting State where:
(a)
The person is considered under the taxation law of the other Contracting
State to have derived the amount through an entity that is not a resident of the
first-mentioned State, but by reason of the entity not being treated as fiscally
transparent under the laws of that State, the treatment of the amount under
the taxation law of that State is not the same as its treatment would be if the
amount had been derived directly by that person; or
(b) The person is considered under the taxation law of the other contracting State
to have received the amount from an entity that is a resident of that other
State, but by reason of the entity being treated as fiscally transparent under
the laws of the first-mentioned Sate, the treatment of the amount under the
taxation law of that State is not the same as its treatment would be if that
entity were not treated as fiscally transparent under the laws of that State.
59
Canada-U.S. Treaty Issues: Anti-Hybrid Rules
LLC Owning Shares of Disregarded ULC
CRA says the better view is that
U.S. residents cannot claim Treaty
benefits on amounts paid by a ULC
to an LLC where both entities are
and the income item disregarded
for U.S. tax purposes: see CRA
document 2009-0345351C6, dated
February 11, 2010
Consider inserting a third country
(i.e., Luxembourg) between LLC
and ULC, so that a different treaty
applies
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U.S. Residents
LLC
U.S.
Canada
ULC
Canada-U.S. Treaty Issues: Anti-Hybrid Rules
Dividends Paid by Disregarded ULCs
2 - Step Work-Around
Base Case
CRA document 2009-0348581R3
U.S. Corp
U.S. Corp
Dividends
U.S.
Step 2. Return of
PUC Distribution
U.S.
CAN
CAN
ULC
ULC
Step 1. ULC PUC increase (deemed
dividend for Canadian purposes)
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Canada-U.S. Treaty Issues: Anti-Hybrid Rules
Disregarded ULCs and Interest
Base Case
USCo
USCo
Interest-Bearing
Loan
100%
25% Interest
Withholding
Interest-Bearing
Loan
USSub
ULC
USCo
USSub
ULC
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Canada-U.S. Treaty Issues: Anti-Hybrid Rules
Disregarded ULCs and Interest
Alternative 2: Partnership
CRA document 2009-0318491I7
USCo
Interest-Bearing
Loan
90%
USSub
10%
USSub
ULC
63
The End
Thank you
For more on the Canadian taxation of mining, go to
www.miningtaxcanada.com
Steve Suarez
Borden, Ladner Gervais LLP (Toronto)
416 367-6702
ssuarez@blg.com
64