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Glitch will delay ratification of many Canadian tax information exchange agreements


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International tax alert, April 20, 2011

A PDF version of this article can be downloaded below.

The March 22, 2011 Federal Budget contained an obscure provision noting the Canadian government’s intention to amend the Excise Tax Act and the Excise Act, 2001 to include references to tax information exchange agreements (TIEAs) within the definitions in those Acts of “listed international agreement”. From our discussions with the Department of Finance it is now clear that, until these amendments are introduced and receive Parliamentary approval, several TIEAs that Canada has signed and that have otherwise been the subject of all necessary Parliamentary procedures cannot be ratified and come into effect. This may delay the ability of foreign affiliates resident in those jurisdictions to earn “exempt surplus” for Canadian tax purposes.

The affected TIEAs are those that apply to all taxes imposed by the government of Canada, including excise taxes, or that specifically apply to goods and services taxes, and include TIEAs with the following jurisdictions that have been signed and otherwise undergone the necessary Parliamentary approvals (i.e., they were tabled in the House of Commons and the House was in session for the required 21 days):

  • Anguilla
  • The Bahamas
  • Dominica
  • St. Lucia
  • San Marino
  • St. Kitts and Nevis
  • St. Vincent and the Grenadines
  • Turks and Caicos Islands

It is likely that the necessary amendments will be introduced at the earliest opportunity after the May 2, 2011 federal election since they are not considered to be controversial. However, it is difficult to predict when they might become law.

TIEAs that are restricted in their application to Canadian income and capital taxes, such as the TIEAs that have been signed with Bermuda and the Cayman Islands, are not affected by this problem. We have been told by the Department of Finance that Bermuda and the Cayman Islands have informed Canada that they have completed the necessary approval procedures on their part, and these TIEAs were tabled in the House of Commons for the required period. These TIEAs can be ratified through the exchange of notifications when Parliament returns following the federal election. The TIEA with Netherlands Antilles[1] that was ratified on January 1, 2011 is also applicable only to income and capital taxes and therefore is also unaffected by the problem that has been identified with the excise tax legislation.

Canada has also signed TIEAs with Guernsey, Jersey and the Isle of Man. While these TIEAs apply only to income and capital taxes, they need to be tabled in the House of Commons after the election in order to meet the required notice period.

Consequences of entering into a TIEA

A TIEA is an agreement that sets out a framework for exchanging information between countries to help administer and enforce tax laws. TIEAs are typically based on the Organisation for Economic Cooperation and Development (OECD) internationally agreed standard, and have a primary function of helping to prevent tax evasion in situations where there is no comprehensive double taxation treaty (tax treaty) in place between the two countries concerned.

To provide an incentive for such countries to enter into TIEAs with Canada, the Income Tax Regulations were amended in 2008 to extend to TIEA countries certain favourable corporate tax provisions that had previously only been available to countries with which Canada has concluded a tax treaty. These incentives provide that, if a jurisdiction enters into a TIEA with Canada, active business income earned by a foreign affiliate of a Canadian corporation that is resident in that jurisdiction and carrying on business there will be included in exempt surplus, and consequently, dividends paid to the Canadian corporation from the affiliate will not be subject to Canadian tax. Exempt surplus treatment is also available for a foreign affiliate that is resident in another country with which Canada has a tax treaty or TIEA if it is carrying on an active business through a permanent establishment located in a TIEA jurisdiction. If a foreign affiliate is resident in a jurisdiction that has not entered into a tax treaty or TIEA with Canada, such a dividend from the affiliate to its Canadian parent company is subject to full taxation in Canada, subject to relief for any foreign taxes paid.[2]

The rules are actually less restrictive for foreign affiliates resident in TIEA countries than they are for foreign affiliates resident in tax treaty countries. While in either case a foreign affiliate must satisfy the common law test for residency in the particular jurisdiction, foreign affiliates resident in a tax treaty country must also generally be subject to tax in their country of residence under the terms of the tax treaty with Canada.[3] 

The regulations provide that exempt surplus treatment will be available for the taxation year of a foreign affiliate in which the TIEA enters into force.[4] Therefore, if a particular TIEA is ratified in 2011, a foreign affiliate that has a taxation year based on the calendar year will be eligible to earn exempt surplus for its entire 2011 taxation year.

It should be noted that in 2007 the Minister of Finance created an Advisory Panel on Canada’s System of International Taxation (the “Panel”). One of the key recommendations made in the Panel’s 2008 report was to treat active business income earned in any country as exempt surplus, whether or not that country has entered into a tax treaty or a TIEA with Canada. The Panel also recommended that the punitive measures aimed at jurisdictions that have declined to enter into a TIEA with Canada be repealed. At this time, it is not clear whether the Panel’s recommendations in this respect will ever be adopted.

Sandra Slaats, Toronto

Ruth Woolmer, Toronto


[1] The Netherlands Antilles ceased to exist on October 10, 2010. However, the Netherlands has advised Canada that the TIEA will apply to Curacao, Sint Maarten and the islands of Bonaire, Sint Eustatius and Saba.
[2]Punitive measures were also enacted to encourage countries to enter into TIEAs. Generally, if a country does not sign a TIEA with Canada within 60 months of beginning negotiations or a request from Canada to begin negotiations, active business income earned by a foreign affiliate resident in that country may be taxed in Canada on an accrual basis as foreign accrual property income (subsection 95(1), definition of “non-qualifying country”).
[3]Regulation 5907(11.2).
[4]Regulation 5907(11.11) provides that, where a TIEA comes into force on a particular day, it is deemed to come into force on the first day of a foreign affiliate’s taxation year that includes that day.

 

 

This publication is produced by Deloitte & Touche LLP as an information service to clients and friends of the firm, and is not intended to substitute for competent professional advice. No action should be initiated without consulting your professional advisors. Your use of this document is at your own risk.