Overview of international taxation in Canada

1. International taxation in Canada 1

2. overview Taxation of non-residents with Canadian investments or business dealings Tax treatment of international transactions with Canadian residents Taxation of Canadian residents with foreign investments Basic application of tax treaties on taxation of various sources of income Application of tax compliance requirements for above 2

3. International tax Canadians hold a significant amount of foreign investments and vice versa Tax consequences as a result of these holdings Highly complex area and many practitioners specialize in this area 3

4. liability Concept of residency revisited Citizenship is not relevant Residents are taxed on worldwide income Receive credit for taxes paid in foreign jurisdictions Non residents are liable for tax 4

5. Non residents The Act provides that individuals who are not resident but are taxable on the following Was employed in Canada Carried on a business in Canada Disposed of taxable Canadian property At any time during the year calculated in accordance with Division D 5

6. Definition includes Real or immovable property in Canada Property used or held in ECE or inventory of a business Shares of a corporation resident in Canada that are not listed Shares of NR corporation that are not listed if during the prior 60 months surpassed certain Canadian asset thresholds Shares of a Canadian resident corporation that are listed where within prior 60 months owned not less that 25% of the shares Interest in a partnership Capital interest in Canadian resident trust Units of a Canadian resident trust Units of mutual funds Interest in nonresident trusts if certain thresholds surpassed Interest in or option in respect of the above 6

7. Definition extensions Canadian resource properties Timber resource properties Income interest in a Canadian resident trust Certain partnership agreements Canadian life insurance policies 7

8. Most common Real property Property used in business Unlisted shares of private corporation 8

10. Part year residents Income, deductions and credits A person may be part-time resident in only two conditions Where a Canadian resident leaves (clean break) When a foreign resident arrives (fresh start) Income based on time in Canada Some credits are prorated Personal tax, age, disability Others are claimed in full Pension, Canada employment, medical, charitable Public transit, fitness, adoption expenses 10

11. Example Aaron Levy immigrated to Canada during 2008, arriving on August 15. He earned salary in Israel of C$35,000 before coming to Canada. On arriving, he went to work for the City of Winnipeg, where he earned $15,000 in employment income. He also attended the University of Winnipeg on a part-time basis for four months and his tuition fees were $900 What is his tax situation? 11

12. Solution 12

13. Solution 13

14. Solution 14

15. Deemed acquisition on entry Taxpayers deemed to dispose of immediately before entry and acquiring at FMV Ensures that taxed only on gains made after becoming resident 15

16. Example When Aaron came to Canada he had 5,000 shares of a pubco on the NYSE. He paid US$18 per share and FMV when he came to Canada was US$24 and the forex rate was 1.02 What is his ACB for tax purposes? If he sold them in 2008 for C$32 (assume forex rate is 1.03) per share, what is his taxable amount? 16

17. Solution 17 Aaron is deemed to have acquired the shares at US$24, or US$120,000 in total. ACB when he enters Canada is C$24.48 or C$122,400 On disposition he includes taxable gain as follows:

18. other Deemed rules do not apply to the following: Taxable Canadian property Inventory of a business carried on in Canada ECP of a business in Canada Salary deferral arrangements, RPPs, RRSPs, rights to CPP and OAS 18

19. Deemed disposition on leaving Canada When a taxpayer gives up Canadian residency, there is a deemed disposition at FMV for both capital and non capital This ensures that Canada receives fair share of taxes on accrued gains before departure Latest of: Date individual leaves Canada Spouse or dependents leave Canada Individual becomes resident of another country 19

20. Example Carol Ann Thomas emigrated from Canada this year. At the time she left, she owned 500 shares of XYZ Ltd, a listed company. FMV was $20 and ACB $8 What is Carol Ann’s Canadian tax position on these shares? 20

21. Solution 21

22. exemptions Real property in Canada Property of a business carried on in Canada Pensions, RRSPs etc Properties if short term resident (less than 60 months in a 10 year period) Property of a returning nonresident where taxpayer elects to unwind the deemed disposition 22

23. Non residents Income earned in Canada by non residents Was employed in Canada Carried on a business in Canada Disposed of taxable Canadian property Need to file tax return Exempt from filing if: No tax is payable under Part I Non resident does not owe tax from prior years Disposed of excluded property (includes treaty-protected property) 23

24. Determinations Employment income Same criteria as residents Contractor vs employee argument again Source deductions may be required Business income Issue of residency (same criteria as permanent establishment) Use of facilities Maintenance of goods for sale Purchase of goods for sale advertising 24

25. example A US corporation Tellco Inc employs three employees who live and work in Canada. The sales employees work from home offices. Tellco does not have an office or other facility in Canada. The employees are paid monthly salaries and quarterly commissions based on sales volume. The employees solicit sales from Canadian customers. The customers order products directly from the US company online or by phone. Goods are shipped directly from the US warehouse to Canadian customers. Is Tellco carrying on a business in Canada? Does Tellco have a permanent establishment in Canada? Does Tellco have a withholding requirement for Canadian employees? 25

26. Issue 1 Tellco is offering product for sale in Canada through a servant (employee) and would be considered to be carrying on business in Canada under domestic law. 26

27. Issue 2 Tellco would be deemed to have a permanent establishment in Canada, if the employees negotiate and habitually conclude contracts in Tellco’s name. As long as the sales contracts are concluded in the US, Tellco would not have a permanent establishment in Canada. The Convention overrides Canadian tax law. 27

28. Issue 3 Source deductions are required for payments of salary, wages or other remuneration. Remuneration includes commissions paid to an officer or employee. Tellco must withhold and remit prescribed amounts to the Receiver General for the Canadian employees. Assuming that the employees are residents of Canada, Canadian personal tax returns will be filed and the withholdings will reduce the taxes payable on the returns 28

29. Branch tax Imposed on non Canadian corporations carrying on business in Canada through separate entity not incorporated in Canada 25% in addition to Part I tax Paid on branch income not retained in Canada Tax treaty with US limits rate to 5% 29

30. Example 30 International Links Inc is a telecommunications company incorporated in the US with a December 31 year end. It began operating one small pilot project office in Toronto in 2007 in addition to its 52 US offices. The corporation is not resident in Canada; the office is considered a permanent establishment. Taxable income from operations are listed. What is the corporate tax liability?

31. solution 31

32. Withholding taxes Non residents liable for tax Part XIII of the Act requires a resident who pays or credits certain amounts to non residents to withhold 25% unless otherwise stated in tax treaty Part XIII is different from Part I – one or the other is paid Common types of income: Management fees Interest paid or payable to NAL person Estate or trust income Rents and royalties Pension benefits RRSP payments Deferred profit sharing plan payments Annuity payments Taxable dividends and capital dividends 32

33. discussion Janet Smith is about to emigrate from Canada. She has $50,00 in her RRSP What are her alternatives in connection with the RRSP? 33

34. solution Janet could collapse her RRSP prior to leaving Canada. In this case, the RRSP would be included in her income in her final Canadian tax return and taxed at her marginal rate. Alternatively, she could collapse her RRAP after leaving Canada, paying 25% withholding tax. Need to choose the approach which will produce the lesser tax 34

35. Rental income The 25% may be punitive as it is applied to GROSS rental income. There may be mortgage payments etc that are funded by the rental income Can elect to file a return and report income and expenses and needs to elect to pay tax on the net income, within 6 months. 35

36. example Jack Lajoha is a resident of Spain but has a rental property in Canada. The gross rents are $1500 monthly and are collected by his agent Tom Kelly. From the rental income, Tom pays his agent fee, mortgage, property taxes and maintenance of $14,400. Available CCA on the property will be $5,000 for 2008. On average, there is about $300 a month net cash flow available. How does Jack account for the rental income in Canada? 36

37. solution 37 Tom is required to deduct 25% of the gross rents and remit to CRA as withholding tax. The withholding tax of $375 exceeds the average monthly net cash flow. Jack can choose to file and receive a refund of the withholding tax over the actual tax required

38. Tax treaties Broken down into Articles which govern how various items are treated: Article IV – residency (tie breaker article) Article V – permanent establishment Article XI – interest Article XIII – capital gains (gains of US residents are exempt from tax in Canada unless real property or a share in Canadian resident corporation; gains of Canadian residents are exempt from US law) 38

39. Cross border transactions Transfer pricing A situation where a Canadian taxpayer buys or sells products or services to a related non-resident person where pricing may be an issue Canadian importer might arrange with a supplier that any goods purchased be first sold to a wholly owned subsidiary in a tax haven. The wholly owned sub then resells to Canco at a price that includes a profit to the sub. As the sub is in a tax haven, any profits made are not taxed. In essence, the profit has been shifted out of Canada Adjustments will apply if a taxpayer and NAL NR participate in a transaction where the terms and conditions differ from those in an arms length transaction Penalty of 10% if adjustment is required Penalty will not apply if reasonable effort made to price the tranaction 39

40. Cross border transactions Thin capitalization Where NR shareholders own 25% or more of votes or FMV of a Canadian corporation Prevents shareholders from removing profits from corporation by way of tax free interest rather than dividends A(B – (2 x C))/B A = interest otherwise deductible B = average of outstanding debts C = sum of beginning retained earnings for the year, the average of the NR share of beginning contributed surplus, and the average of beginning PUC for the NR shares 40

41. example Canada Corp is held 100% by non residents. The existing equity in the company is $200,000 (sum of equity, PUC and contrib surplus). Interest paid on a $1 million debt was $125,000 What is the impact if any on the thin capitalization of the company? 41

42. solution Use the formula to limit the interest amount A(B – (2 x C))/B 125,000 interest – (1,000,000 – (2 x 200,000))/1,000,000 $75,000 Canada Corp can deduct $50,000 (125,000 interest paid - $75,000 non deductible under 18(4)) 42

43. Information reporting Required to report annually if own foreign property with value of greater than C$100,000 If yes, need to report what kind of income was received, the cost of property, and location of property. Failure to file is $500/month penalty up to 24 months ($12,000) 43