Canada: Amendments to Canadian international tax proposals
Chris Van Loan
On August 29 2014, the Canadian Department of Finance released a package of amendments (the August 29 Release) to the Income Tax Act (ITA) implementing or modifying, among other things, some of the international tax proposals contained in the federal government's 2014 Budget. The 2014 Budget featured a number of proposals with an international focus, including a rule to be added to the ITA intended to combat international treaty shopping. The latter proposal seemed to indicate an intention not only to participate in the G20/OECD base erosion and profit shifting (BEPS) initiative, but also to implement certain domestic anti-treaty shopping rules before the completion of that initiative. One of the surprises in the August 29 Release was the announcement that, having engaged in consultations, the government had decided instead to await further BEPS developments. The August 29 Release also includes extensive amendments to some of the federal government's other international tax proposals, including those relating to foreign affiliate dumping.
Another key feature of the 2014 Budget was the extension of the thin capitalisation rules in the ITA (which, broadly speaking, restrict a Canadian taxpayer's ability to deduct interest on debt owing to "specified non-residents"), and related withholding tax provisions, to certain back-to-back (BTB) arrangements. According to technical notes released by the Department of Finance concurrently with the 2014 Budget, the BTB rules targeted arrangements that "involve interposing a third party (for example, a foreign bank) between two related taxpayers (such as a foreign parent corporation and its Canadian subsidiary) in an attempt to avoid the application of rules that would apply if a loan were made, and interest were paid on the loan, directly between the two taxpayers".
The BTB proposals in the 2014 Budget were widely criticised as possibly over-reaching insofar as it was thought, despite the evident focus of the amendments, they might nevertheless encompass many common commercial arrangements which had neither the intention nor the effect of circumventing the thin capitalisation rules and, among other things, where it was clear that the direct lender was using its own financial resources and not simply intermediating the deployment of internal taxpayer group funds. Of particular concern were loans to Canadian businesses where a non-resident (with a significant economic interest in the borrower, such as owning 25% or more of the shares of the borrower) provided security for the loan. The August 29 Release narrowed the scope of this part of the BTB rules so that security provided by a non-resident would not taint a loan unless the lender is granted a right to "use, mortgage, hypothecate, assign, pledge or in any way encumber, invest, sell or otherwise dispose of, or in any way alienate" the property subject to the security.
Although time may well reveal unsuspected adverse tax developments within the August 29 Release, many of the modifications as they relate to the BTB proposals specifically have been welcomed by the tax community.
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