While other countries have reacted to US tax reform by making their systems more attractive, Canada instead opted to announce in its budget on February 27 a tightening of its rules on controlled foreign companies (CFCs) and target surplus stripping methods.
“We know businesses are concerned about the outcome of North American Free Trade Agreement talks, and tax changes in the United States,” said Canadian Finance Minister Bill Morneau. “We will be vigilant in making sure Canada remains the best place to invest, create jobs and do business—and we will do this in a responsible and careful way, letting evidence, and not emotion, guide our decisions.”
“At the same time, we need to stay focused on our long-term goal of building an economy that works for everyone,” he added.
Canada had not been expected to be reactive to tax reform south of its border, with Morneau saying in the run-up to the budget that he would not make an “impulsive” response despite a feeling among the business community that the corporate tax rate will need to fall.
The government has enlisted the Department of Finance to conduct a detailed analysis of US tax reforms to determine their impact on Canada, but no time scale has been given for this review.
“There is a broad sense in the Canadian business community that some action is needed to address the major changes taking place in the US, including dramatic corporate tax rate reductions, and the move to current expensing of capital investments,” said Josh Jones, a Toronto-based partner at Blake, Cassels & Graydon. “Yet the government seems in no hurry to take action on this front.”
“The Budget was relatively light on new tax measures for multinational businesses,” he added. “So the key takeaway is that it is business as usual.”
Information sharing
While Morneau’s previous two budgets have cracked down on tax avoidance, the 2018 iteration did not place many new rules on the way companies can structure their tax affairs.
Perhaps of more interest is that the budget will allow the sharing of information with Canada’s tax treaty and tax information exchange agreement partners using the legal tools available under the Mutual Legal Assistance in Criminal Matters Act (MLACMA).
“These tools include the ability for the Attorney General to obtain court orders to gather and send information,” reads an annex of supplementary budget information. “The Canada Revenue Agency will continue to be involved in sharing tax information internationally and will work with the Department of Justice, which administers the MLACMA.”
Countries which Canada will share information with include the US, France, Russia and China. Given the precedent of computer hacking in some of the jurisdictions, taxpayers may be at risk of sensitive information being made public.
The measures, which were not mentioned in the budget speech, have drawn criticism from political opponents of the Liberal Party.
Surplus stripping rules
While the budget did not bring in vast swathes of anti-avoidance legislation, “one new measure is aimed at structures used to ‘strip’ surplus out of Canadian corporations through the use of trusts or partnerships in a way that circumvented existing surplus stripping rules”, said Jones.
An amendment to section 212.1 of the Income Tax Act will make it more difficult for multinationals to extract the Canadian corporations’ surpluses on a non-arm’s length basis by extending its scope to include partnerships and trusts.
Section 212.1 governs the disposal of shares by non-resident corporations to another corporation in certain circumstances.
“The specific anti-avoidance rule in section 212.1 only applies where shares of a corporation resident in Canada are transferred to the purchaser corporation,” said the Federal Budget commentary of Canadian law firm Stikeman Elliott. The law does not apply in circumstances where interests in some intermediaries, namely partnerships and trusts, are transferred by non-resident corporations. As a result, under the old rules, “a non-resident person can transfer an interest in a partnership, which holds shares of a Canadian corporation, to a non-arm’s length Canadian company and arguably achieve a result which section 212.1 is designed to prevent.”
The budget adds a new ‘look-through’ rule for partnerships and trusts, which will essentially allocate the assets, liabilities and transactions of such entities to its members or beneficiaries based on fair market value.
The new measure is effective from the day of the budget.
Cannabis taxation framework
Canada will become one of the first countries in the world to legalise cannabis (in a regulated and restricted manner) at a federal level later this year, no later than the end of July.
Provinces and territories will have the final say on how they deal with the new market, but the budget annex outlines an aim to “maintain a coordinated cross-country approach to taxation”.
Cannabis cultivators will have to obtain a cannabis licence from the Canada Revenue Agency and remit the excise duty where applicable. The government will impose excise duties on federally-licenced producers.
Under the proposed framework, cannabis products with low levels of tetrahydrocannabinol (the active ingredient) will generally not be subject to excise duty, and instead fall under the Goods and Services Tax/Harmonized Sales Tax regime, which will undergo some changes before legalisation occurs. Cannabis products for medical usage will not be subject to excise duty, but will only be available through a prescription.
