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WELCOME Added experience. Added clarity. Added value. VANCOUVER CALGARY EDMONTON SASKATOON REGINA LONDON KITCHENER-WATERLOO WELCOME Added experience. Added clarity. Added value. VANCOUVER CALGARY EDMONTON SASKATOON REGINA LONDON KITCHENER-WATERLOO GUELPH TORONTO MARKHAM MONTRÉAL

Tax Essentials for IT Law October 27, 2015 David W. Chodikoff, Tax Partner 416. Tax Essentials for IT Law October 27, 2015 David W. Chodikoff, Tax Partner 416. 595. 8626 [email protected] com With assistance from: Benjamin Mann, Student-at-Law

AGENDA 1. Residency, permanent establishment and the challenges of electronic commerce 2. Foreign tax AGENDA 1. Residency, permanent establishment and the challenges of electronic commerce 2. Foreign tax basics for the expanding global technology enterprise 3. Double taxation: causes and methods of relief 4. International tax evasion and the General Anti. Avoidance Rule (GAAR) 3

Canada’s Tax Base • Canada bases its taxation on its residents’ worldwide income – Canada’s Tax Base • Canada bases its taxation on its residents’ worldwide income – Section 2(1) of the Income Tax Act, RSC 1985, c 1 (5 th Supp. )(the “ITA”): • An income tax shall be paid… on the taxable income for each taxation year of every person resident in Canada at any time in the year 4

Determining Who is a Resident • Tax residency under the common law: – De Determining Who is a Resident • Tax residency under the common law: – De Beers Consolidated Mines, Limited v. Howe (Surveyor of Taxes), [1905] 2 K. B. 612 • The proper test to determine corporate residence is where the real business is carried on, and the real business is carried on where central management and control actually abide. 5

Determining Who is a Resident (cont’d) • Statutory residence: – ITA s. 250(4): • Determining Who is a Resident (cont’d) • Statutory residence: – ITA s. 250(4): • (a) For the purposes of this Act, a corporation shall be deemed to have been resident in Canada throughout a taxation year if – in case of a corporation incorporated after April 26, 1965, it was incorporated in Canada; 6

Determining Who is a Resident (cont’d) • Tax treaties impose a tie-breaker: – Paragraph Determining Who is a Resident (cont’d) • Tax treaties impose a tie-breaker: – Paragraph 3, Article 4, of the 2014 version of the OECD Model Tax Convention: “where a corporation would be resident of more than one state, it shall be deemed to be a resident only of the state in which its effective management is situated” – ITA s. 250(5): Notwithstanding any provision of the ITA, where a taxpayer would be a resident of Canada but for a tax treaty, that tax treaty determine residency 7

The Challenges of Electronic Commerce in Determining Residency • Electronic commerce poses unique challenges The Challenges of Electronic Commerce in Determining Residency • Electronic commerce poses unique challenges to these traditional tests for determining residence for tax purposes • The effective management test in the era of electronic commerce: • In 2001 the OECD established a Technical Advisory Group (TAG) to address the issue of residency with respect to cross-border electronic commerce 8

Carrying on a Business in Canada • S. 153(b) of the ITA: For the Carrying on a Business in Canada • S. 153(b) of the ITA: For the purposes of this Act, where in a taxation year a person who is a non-resident person or a trust to which Part XII. 2 applies: – (b) solicits orders or offers anything for sale in Canada through an agent or servant, whether the contract or transaction is to be completed inside or outside Canada or partly in and partly outside Canada, 9

Carrying on a Business in Canada (cont’d) • the person shall be deemed, in Carrying on a Business in Canada (cont’d) • the person shall be deemed, in respect of the activity or disposition, to have been carrying on business in Canada in the year. 10

Carrying on a Business in Canada (cont’d) • The CRA has commented that in Carrying on a Business in Canada (cont’d) • The CRA has commented that in the GST/HST context, the following factors will be considered in determining whether a non-resident is carrying on business in Canada: – the place where agents or employees of the non-resident are located; – the place of delivery; – the place of payment; – the place where purchases are made or assets are acquired; – the place from which transactions are solicited; 11

Carrying on a Business in Canada, (cont’d) • The CRA has commented that in Carrying on a Business in Canada, (cont’d) • The CRA has commented that in the GST/HST context, the following factors will be considered in determining whether a non-resident is carrying on business in Canada: (cont’d) – the place where the business contracts are made; – the location of a bank account; – the place where the non-resident's name and business are listed in a directory; – the location of a branch or office; – the place where the service is performed; and – the place of manufacture or production. 1 1. Government Publications — Policy Statements, P-051 R 2 -- Carrying on Business in Canada 12

Carrying on a Business in Canada (con’t) • The CRA’s view: 2 – In Carrying on a Business in Canada (con’t) • The CRA’s view: 2 – In determining whether a business is being carried on in Canada the essential question is whether Canada is the place of profit-producing activity – In traditional forms of business, such as a sale of goods, the most important factor is the place of contract 2. CRA Views, Interpretation—external, 2008 -0279141 E 5 -- Electronic commerce—Articles 7 and 12 tax treaties 13

Carrying on a Business in Canada (con’t) • The CRA’s view: (cont’d) – Where Carrying on a Business in Canada (con’t) • The CRA’s view: (cont’d) – Where the business is a service business the business is considered to be carried on at the place the service is performed – Regarding electronic commerce, there are two factors that will be taken into account with respect to an internet business in determining whether a business is being carried on in Canada: (1) the presence of digital inventory in Canada, and (2) the use of a “. ca” domain name. 14

Permanent Establishments • Article 7 of the Model Convention provides that profits of an Permanent Establishments • Article 7 of the Model Convention provides that profits of an enterprise of a contracting state shall be taxable only in that state unless the enterprise carries on business in another contracting state through a permanent establishment. 15

Permanent Establishments (cont’d) • Article 5 of the Model Convention states that a permanent Permanent Establishments (cont’d) • Article 5 of the Model Convention states that a permanent establishment is a fixed place of business through which the business of an enterprise is wholly or partly carried on, and specifically includes: – – – A place of management A branch An office A factory A workshop A mine, an oil or gas well, a quarry or any other place of extraction of natural resources – A building site or construction or installation project that has lasted for more than twelve months 16

Permanent Establishments (cont’d) • A permanent establishment may also be deemed to exist if Permanent Establishments (cont’d) • A permanent establishment may also be deemed to exist if there is a person acting on behalf of an enterprise who has, and habitually exercises, the authority to conclude contracts in the name of that enterprise, unless the activities fall within the specific exclusions outlined on the next slide 17

Permanent Establishments (cont’d) • However, a permanent establishment will not include: – The use Permanent Establishments (cont’d) • However, a permanent establishment will not include: – The use of facilities solely for the purpose of storage, display or delivery of goods or merchandise belonging to the enterprise – The maintenance of a stock of goods or merchandise solely for the purpose of storage, display or delivery; – The maintenance of a stock of goods or merchandise solely for the purpose of processing by another enterprise; 18

Permanent Establishments (cont’d) – The maintenance of a fixed place of business solely for Permanent Establishments (cont’d) – The maintenance of a fixed place of business solely for the purpose of purchasing goods or merchandise or of collecting information for the enterprise; – The maintenance of a fixed place of business solely for the purpose of carrying on, for the enterprise, any other activity of a preparatory or auxiliary character; – The maintenance of a fixed place of business for a combination of any of the above, provided that the overall activity resulting from this combination is of a preparatory or auxiliary character. 19

Determining when Electronic Commerce can Constitute a Permanent Establishment • The OECD Commentary on Determining when Electronic Commerce can Constitute a Permanent Establishment • The OECD Commentary on Article 5 states that a website should not constitute a permanent establishment, since it is only a combination of software and data and cannot constitute property 20

Determining when Electronic Commerce can Constitute a Permanent Establishment (cont’d) • However, a server Determining when Electronic Commerce can Constitute a Permanent Establishment (cont’d) • However, a server on which a website is stored may constitute a permanent establishment: • If the website is only hosted on the server of an independently run ISP, that will probably not constitute a place of business • But if the non-resident owns or leases the server, and operates it at its disposal, that could constitute a permanent establishment if the other criteria of Article 5 are met 21

Recent Developments for Permanent Establishments • On October 5, 2015, the OECD released Final Recent Developments for Permanent Establishments • On October 5, 2015, the OECD released Final Reports relating to the OECD/G 20 base erosion and profit shifting (BEPS) prevention initiatives • Recommendations include new methods for determining if a permanent residence is present and are designed to ensure that the exemptions are restricted to activities that are truly “preparatory and auxiliary” 22

Case Law on Permanent Establishments • Knights of Columbus v. R, 2008 TCC 307 Case Law on Permanent Establishments • Knights of Columbus v. R, 2008 TCC 307 – Facts: • The Knights of Columbus are a US resident corporation that provides life insurance to its Canadian members through Canadian agents • The Knights used 244 agents throughout Canada to operate their insurance program: one Chief Agent, one field director, 22 general agents, and 220 field agents • The chief agent, field director, and general agents were all agents of independent status acting ordinarily in the course of their own business 23

Case Law on Permanent Establishments (cont’d) • Knights of Columbus v. R, 2008 TCC Case Law on Permanent Establishments (cont’d) • Knights of Columbus v. R, 2008 TCC 307 – Facts: • The Minister assessed the company principally on the basis that its insurers qualified as agents with the power to contract • These agents worked from home and were paid on a commission basis. They met with members of the Knights, helped them fill out an application, and send it to the Knights' headquarters in New Haven, Connecticut. 24

Case Law on Permanent Establishments (cont’d) • Knights of Columbus v. R, 2008 TCC Case Law on Permanent Establishments (cont’d) • Knights of Columbus v. R, 2008 TCC 307 – Facts cont’d: • The agents had no authority to bind the company and were free to conduct their businesses as they saw fit • However, when an applicant filled out an application for insurance, they automatically received temporary insurance from the Knight until their application was processed 25

Case Law on Permanent Establishments (cont’d) • Knights of Columbus v. R, 2008 TCC Case Law on Permanent Establishments (cont’d) • Knights of Columbus v. R, 2008 TCC 307 – Judgment: • The field agents were not in the business of selling insurance since they did not have the authority to conclude contracts; the temporary insurance was only an incentive to apply for the general package, and was not the Knights’ business 26

Case Law on Permanent Establishments • American Income Life Insurance Co. v. R. , Case Law on Permanent Establishments • American Income Life Insurance Co. v. R. , 2008 TCC 306 – Facts: • AIL was a US company carrying on the insurance business in Canada focusing on “union people” • They operated through several agents working in a hierarchy • At the top of the hierarchy were the Provincial General Agents (PGAs), who developed and expanded the agency, and recruited, trained and managed other agents • PGAs entered into agency agreements with AIL, but were not employees 27

Case Law on Permanent Establishments • American Income Life Insurance Co. v. R. , Case Law on Permanent Establishments • American Income Life Insurance Co. v. R. , 2008 TCC 306 • Facts: • It was agreed that they carried on a business in Canada, the issue was whether they conducted the business through a permanent establishment • PGAs ran the offices managing lower-level agents, including leasing the premises and were responsible for building the business, although AIL provided signs and forms • Other agents were independent contractors working for commissions, frequently working out of their home offices • They would solicit clients, who would sign contracts that were then sent to AIL, who would review and complete the contracts if satisfied 28

Case Law on Permanent Establishments • American Income Life Insurance Co. v. R. , Case Law on Permanent Establishments • American Income Life Insurance Co. v. R. , 2008 TCC 306 • Judgment: • AIL had no fixed place of business, because all premises were controlled by the agents; AIL did not lease them and had no right of access to them • The agents could not conclude contracts themselves; these were signed by AIL • The agents were not dependent agents, since they were legally and economically independent of the company 29

Case Law on Permanent Establishments • SWS Communication Inc. v. R. , 2012 TCC Case Law on Permanent Establishments • SWS Communication Inc. v. R. , 2012 TCC 114 – Facts: • Canadian corporate GST registrants sold wholesale voice over internet protocol (VOIP) bandwidth to US companies which had Canadian offices but whose communication equipment and principal places of business were located in the US • Unchallenged evidence was that VOIP calls transmitted by US companies originated in US and transmitted to termination points outside of Canada and the US • Minister assessed registrants on basis that they were required to collect GST on supply of telecommunication services to US companies because US companies had permanent establishments in Canada and were therefore resident in Canada 30

Case Law on Permanent Establishments • SWS Communication Inc. v. R. , 2012 TCC Case Law on Permanent Establishments • SWS Communication Inc. v. R. , 2012 TCC 114 – Judgment • Under s. 132(2) of the Excise Tax Act a permanent establishment is only deemed to be resident in Canada in respect of activities they carry on through the establishment • The Minister must show or assume that the supply of VOIP was consumed in the furtherance of activities carried on by the permanent establishment • It was clear that the Minister assumed that the existence of a permanent establishment was sufficient to deem US companies to be resident in Canada and failed to consider whether services supplied were made to US companies' permanent establishments in Canada 31

Intellectual Property and Royalties • Article 12 of the OECD Model Convention: – Royalties: Intellectual Property and Royalties • Article 12 of the OECD Model Convention: – Royalties: payments of any kind received as consideration for the use of, or the right to use, any copyright of literary, artistic or scientific work including cinematographic films, any patent, trade mark, design or model, plan, secret formula or process, or for information concerning industrial, commercial or scientific experience – Paragraph 1 provides that royalties arising in one state and beneficially owned by a resident of another state shall be taxable only in that latter state 32

Withholding Tax • Withholding tax may apply in any circumstance in which a licensing Withholding Tax • Withholding tax may apply in any circumstance in which a licensing agreement is made between a licensor in one country and non-resident licensee in another • Withholding tax in Canada • S. 212(1)(d) of the ITA imposes a 25% withholding tax on the payment of rents and royalties, including: • For the use of or right to use in Canada any property, invention, tradename, patent, trade-mark, design or model, plan, secret formula, etc. • For services of an industrial, commercial or scientific character performed by a non-resident person • This does not include a payment for services performed in connection with the sale of property or the negotiation of a contract 33

Use of a Foreign Subsidiary • In order to reduce the amount of tax Use of a Foreign Subsidiary • In order to reduce the amount of tax payable in Canada, an expanding enterprise should consider the use of a foreign subsidiary • So long as central management and control remains outside Canada, the subsidiary would not be subject to Canadian tax on its worldwide income • A subsidiary will be considered a Foreign Affiliate (FA) if: • A Canadian resident and related taxpayers control more than 10% of the equity 34

Use of a Foreign Subsidiary • A subsidiary will be considered a Controlled Foreign Use of a Foreign Subsidiary • A subsidiary will be considered a Controlled Foreign Affiliate (CFA) if it is an FA and: • It is controlled by a taxpayer resident in Canada; • the taxpayer and not more than four persons resident in Canada; • not more than four persons resident in Canada; or • a person with whom the taxpayer does not deal at arm’s length 35

Foreign Accrual Property Income (FAPI) • Pursuant to the ITA’s foreign accrual property income Foreign Accrual Property Income (FAPI) • Pursuant to the ITA’s foreign accrual property income (FAPI) rules set out in section 95(1), the Canadian parent may be required to include in its income certain income earned by any CFAs • In general, FAPI is income earned by a CFA other than active business income and certain capital gains and includes: • income earned by the CFA from property; and • income earned in a business other than an active business carried on by the CFA. 36

Hybrid Corporations • The Action 2 of the 2015 OECD/G 20 report on Base Hybrid Corporations • The Action 2 of the 2015 OECD/G 20 report on Base Erosion and Profit Shifting defines hybrid mismatch arrangements as arrangements that “exploit differences in the tax treatment of an entity or instrument under the laws of two or more tax jurisdictions to achieve double nontaxation, including long-term deferral” 37

Hybrid Corporations (cont’d) • Hybrid corporations adopt specific structures so as to be taxable Hybrid Corporations (cont’d) • Hybrid corporations adopt specific structures so as to be taxable as a corporation in one jurisdiction, but disregarded for tax purposes in another • Generally, there is a conflict between the transparency and opacity of the entity for tax purposes in relation to a particular payment. 38

Double taxation: causes and methods of relief • The OECD describes double taxation as Double taxation: causes and methods of relief • The OECD describes double taxation as occurring when the same income is taxed in the hands of the same taxpayer by more than one state • Causes of double taxation: 1 • • • Residence-source conflicts Residence-residence conflicts Source-source conflicts Inconsistent views of the relevant facts Inconsistent attribution rules 1. The following discussion is largely based on Arthur Cockfield et al, Taxing Global Digital Commerce, (The Netherlands: Klewer International Law BV, 2013) Chapter 3. 39

Residence-Source Conflicts • Most countries tax residents on income from all sources, foreign and Residence-Source Conflicts • Most countries tax residents on income from all sources, foreign and domestic • Most countries tax non-residents on all income from a source within the country • In the absence of any rules providing relief from double taxation, a person earning source income in one country while resident in another will have the same income taxed twice 40

Residence-Source Conflicts (cont’d) • Some methods of relief: – Exemption • Entirely exempt foreign-sourced Residence-Source Conflicts (cont’d) • Some methods of relief: – Exemption • Entirely exempt foreign-sourced income from taxation – Credits: • Provide tax credits for any taxes already paid to other governments • Foreign-sourced income will still be taxed, but only to the extent foreign governments have not done so already • If a source-country government has taxed income at a rate higher than the residence-country would have, there will be no further tax relief at that time – Deductions: • Some countries allow corporations to deduct those taxes already paid to foreign governments • A much less effective way to resolve the problem of double taxation than credits 41

Foreign Tax Credit (FTC) • Section 126 of the ITA sets out rules enabling Foreign Tax Credit (FTC) • Section 126 of the ITA sets out rules enabling a Canadian resident who earns directly income from abroad to claim a foreign tax credit in respect of any “income or profits” taxes levied against that income or profits • The FTC allowable is the lesser of: – The foreign taxes paid; or – The amount determined by the formula: • (foreign income/worldwide income) X (Canadian tax otherwise payable) 42

Foreign Tax Credit (FTC) (cont’d) • S. 126(2)(a): – The FTC is calculated on Foreign Tax Credit (FTC) (cont’d) • S. 126(2)(a): – The FTC is calculated on a country by country basis, so credits used to offset taxes paid to the American government cannot be used to offset taxes paid to the French government. – Credits against taxes levied by each country can be carried forward for up to 3 years, or backwards for up to 10 years 43

Foreign Tax Credit (FTC) (cont’d) • Sections 20(11) and 20(12) – Under these provisions, Foreign Tax Credit (FTC) (cont’d) • Sections 20(11) and 20(12) – Under these provisions, a Canadian resident is entitled to a credit against any non-business income taxes levied by a foreign government, to a maximum tax rate of 15% – Any amount in excess of 15% is deductible, not creditable 44

Foreign Tax Credit (FTC) case law • White v R, 2003 TCC 668 – Foreign Tax Credit (FTC) case law • White v R, 2003 TCC 668 – Facts: • Taxpayer was a Canadian resident and had shares in several Australian companies • He received from Australian companies dividends which were "fully-franked", "partly-franked" and "un-franked" • Fully-franked dividends were paid from tax-paid earnings of companies, and shareholders received "imputation tax credit" (ITC) which Australian residents could apply against their taxes payable 45

Foreign Tax Credit (FTC) case law (cont’d) • White v R, 2003 TCC 668 Foreign Tax Credit (FTC) case law (cont’d) • White v R, 2003 TCC 668 – Facts: (cont’d) • Partly-franked dividends were paid partly from tax-paid income and carried a smaller value ITC • Un-franked dividend carried no ITC and were subject to withholding tax upon payment to any shareholder who was not a resident of Australia • The taxpayer attempted to claim FTCs for the amounts he would have been credited by the Australian government if he had been an Australian resident 46

Foreign Tax Credit (FTC) case law (cont’d) • White v R, 2003 TCC 668 Foreign Tax Credit (FTC) case law (cont’d) • White v R, 2003 TCC 668 – Judgment: • The taxpayer could not claim a credit against tax he himself had not paid • His dividends may have been less valuable to him than an Australian shareholder, but this did not bring him within the language of s. 126 47

Foreign Tax Credit (FTC) case law • Zhang v. R. , 2007 TCC 634 Foreign Tax Credit (FTC) case law • Zhang v. R. , 2007 TCC 634 – Facts: • Taxpayer was resident in Canada but employed in the United States • He paid employment taxes to the US government, but also received the US child tax credit • He then attempted to use the pre-credit amount for the purpose of claiming the Canadian FTC 48

Foreign Tax Credit (FTC) case law (cont’d) • Zhang v. R. , 2007 TCC Foreign Tax Credit (FTC) case law (cont’d) • Zhang v. R. , 2007 TCC 634 • Judgment: • The taxpayer was only permitted to claim a credit against the amount actually paid to the foreign government • “The purpose of the foreign tax credit is to prevent double taxation 4 by permitting a deduction from a taxpayer's tax liability in Canada an amount equal to the income tax paid "to the government of a country other than Canada”. ” 49

Foreign Tax Credit (FTC) case law (cont’d) • 4145356 Canada Limited v. R. , Foreign Tax Credit (FTC) case law (cont’d) • 4145356 Canada Limited v. R. , 2011 TCC 220 – Facts: • The taxpayer purchased an interest in a Delaware limited partnership • The partnership elected to be taxed as a corporation for US tax purposes and claimed an FTC for the amounts paid • The Minister denied the credit because under US law a separate legal entity had paid the tax, and under s. 126 the person claiming the FTC must be the person actually liable for the tax 50

Foreign Tax Credit (FTC) case law (cont’d) • 4145356 Canada Limited v. R. , Foreign Tax Credit (FTC) case law (cont’d) • 4145356 Canada Limited v. R. , 2011 TCC 220 • Judgment: • The corporation’s tax liability had to be determined in accordance with its treatment under the ITA • Although the US treated the partnership as a corporation, that did not affect its treatment under Canadian tax law • In determining the taxpayer’s foreign taxes, the amount should be its share of the foreign taxes paid by the partnership in relation to the taxpayer’s share of the income 51

Foreign Tax Credit (FTC) case law (cont’d) • FLSmidth Ltd. v. R. , 2013 Foreign Tax Credit (FTC) case law (cont’d) • FLSmidth Ltd. v. R. , 2013 FCA 160 • Facts: – FLSmidth was a wholly owned subsidiary of GL&V, a corporation that used a cross-border structure to acquire US businesses in a tax-efficient manner – FLSmidth and GL&V were members of a limited partnership (LP) that owned a Nova Scotia ULC (NSULC), which was the sole member of a Delaware LLC that elected to be a corporation for US tax purposes – GL&V also owned GL&V Holdings, a US resident subsidiary 52

Foreign Tax Credit (FTC) case law (cont’d) • FLSmidth Ltd. v. R. , 2013 Foreign Tax Credit (FTC) case law (cont’d) • FLSmidth Ltd. v. R. , 2013 FCA 160: cont’d • Facts: (cont’d) – A syndicate of third-party lenders advanced loans to LP, which then acquired shares in NSULC, which used the proceeds to acquire additional interests in the LLC – The LLC used these funds to make interest-bearing loans to GL&V Holdings – During the year, the LLC used the money it made on these loans to issue dividends to NSULC, which used the proceeds to issue dividends to LP, which used a portion of the dividends to pay interest on the third-party loans 53

Foreign Tax Credit (FTC) case law (cont’d) • FLSmidth Ltd. v. R. , 2013 Foreign Tax Credit (FTC) case law (cont’d) • FLSmidth Ltd. v. R. , 2013 FCA 160: cont’d • Facts: (cont’d) – The nature of the entities involved led to different tax consequences in the US than in Canada – In the US, the interest on the loan from LLC to GL&V Holdings and the dividends were all disregarded for tax purposes, and the LP was perceived to have received revenue in the form of interest on the LLC loans and to have paid deductible interest on the third-party loans. The difference between these amounts gave rise to taxable profits in the hands of the LP – FLSmidth claimed a deduction under s. 20(12), arguing that it could deduct US taxes paid on the LP’s profits, which the CRA disallowed 54

Foreign Tax Credit (FTC) case law • FLSmidth Ltd. v. R. , 2013 FCA Foreign Tax Credit (FTC) case law • FLSmidth Ltd. v. R. , 2013 FCA 160 cont’d: • Judgment: • The taxpayer could deduct an amount paid to a foreign government in respect of a source property income, unless that amount could be reasonably regarded as having been paid in respect of income from a share in the capital stock of a corporation • Since the income earned by the corporation was in the form of dividends from a US affiliate, the taxpayer could not claim the deduction • The phrase “in respect of”, which is used twice in the judgment, is sufficient to permit the ultimate tracing of income to the US LLC 55

Residence-Residence Conflicts • Double taxation may arise when two countries employ different methods for Residence-Residence Conflicts • Double taxation may arise when two countries employ different methods for determining residence • i. e. where one country employs a place of incorporation test and another employs an effective management test to determine a corporation’s residency, both countries may claim to be the country in which the corporation is resident 56

Residence-Residence Conflicts (cont’d) • Generally, where the is a dispute as to residency countries Residence-Residence Conflicts (cont’d) • Generally, where the is a dispute as to residency countries will incorporate the effective management test discussed earlier in this presentation, or if there is a tax treaty, the permanent resident test 57

Source-Source Conflicts • Countries may classify the same income as having been sourced in Source-Source Conflicts • Countries may classify the same income as having been sourced in a different location • i. e. dividend income could arise either in the country in which the corporation resides, the shares are held, or the shareholder resides • Tax treaties resolve these conflicts by deciding where certain types of income are deemed to be sourced. 58

Inconsistent Views of the Relevant Facts and Inconsistent Attribution Rules • Inconsistent views of Inconsistent Views of the Relevant Facts and Inconsistent Attribution Rules • Inconsistent views of the relevant facts: – Different countries may ascribe different legal significance to the same event • Inconsistent attribution rules: – Different attribution rules can lead to double taxation if different countries see view income as being in the hands of different people 59

Inconsistent Views of the Relevant Facts and Inconsistent Attribution Rules • Unfortunately, neither domestic Inconsistent Views of the Relevant Facts and Inconsistent Attribution Rules • Unfortunately, neither domestic laws or tax treaties are very effective at reducing taxation stemming from diverging characterizations of income 60

Black v. R, 2014 TCC 12 – Facts: • Conrad Black was a resident Black v. R, 2014 TCC 12 – Facts: • Conrad Black was a resident of the UK from 1992 to 2002 • In 2002 he was also a resident of Canada • By virtue of Paragraph 2 of Article 4 of the Canada-United Kingdom Income Tax Convention he was deemed to be a resident of the UK for tax purposes • However, he was not domiciled in the UK, and therefore was only subject to such income as was remitted to the UK • No income was remitted to the UK in 2002 61

Black v. R, 2014 TCC 12 (cont’d) – Judgment: • There is a distinction Black v. R, 2014 TCC 12 (cont’d) – Judgment: • There is a distinction between being resident for the purpose of a tax treaty and for the purpose of the ITA • The treaty only provides one state with a preference over the taxpayer’s attachment to another state • If there is no double taxation, and no conflict between two states’ claims, then the treaty does not provide relief from being taxed in the state in which one is domiciled 62

Introduction to the General Anti. Avoidance Rule (GAAR) • ITA s. 245 – (2) Introduction to the General Anti. Avoidance Rule (GAAR) • ITA s. 245 – (2) Where a transaction is an avoidance transaction, the tax consequences to a person shall be determined as is reasonable in the circumstances in order to deny a tax benefit that, but for this section, would result, directly or indirectly, from that transaction or from a series of transactions that includes that transaction. 63

Introduction to the General Anti. Avoidance Rule (GAAR) (cont’d) • ITA s. 245 – Introduction to the General Anti. Avoidance Rule (GAAR) (cont’d) • ITA s. 245 – (3) An avoidance transaction means any transaction • (a) that, but for this section, would result, directly or indirectly, in a tax benefit, unless the transaction may reasonably be considered to have been undertaken or arranged primarily for bona fide purposes other than to obtain the tax benefit; or • (b) that is part of a series of transactions, which series, but for this section, would result, directly or indirectly, in a tax benefit, unless the transaction may reasonably be considered to have been undertaken or arranged primarily for bona fide purposes other than to obtain the tax benefit. 64

Introduction to the General Anti. Avoidance Rule (GAAR) (cont’d) • ITA s. 245 – Introduction to the General Anti. Avoidance Rule (GAAR) (cont’d) • ITA s. 245 – (4) Subsection (2) applies to a transaction only if it may reasonably be considered that the transaction • (a) would, if this Act were read without reference to this section, result directly or indirectly in a misuse of the provisions of any one or more of – (i) this Act, – (ii) the Income Tax Regulations, – (iii) the Income Tax Application Rules, – (iv) a tax treaty, or – (v) any other enactment that is relevant in computing tax or any other amount payable by or refundable to a person under this Act or in determining any amount that is relevant for the purposes of that computation; or • (b) would result directly or indirectly in an abuse having regard to those provisions, other than this section, read as a whole. 65

Canada Trustco Mortgage Co. v. R. , 2005 SCC 54 • Canada Trustco outlines Canada Trustco Mortgage Co. v. R. , 2005 SCC 54 • Canada Trustco outlines a three-step analysis to apply the GAAR: 1. Determining whethere is a tax benefit arising from a transaction or series of transactions 2. Whether the transaction is an avoidance transaction under s. 245(3) 3. The avoidance transaction giving rise to the benefit must be abusive per s. 245(4) 66

A Tax Benefit Arising From a Transaction or Series of Transactions • ITA section A Tax Benefit Arising From a Transaction or Series of Transactions • ITA section 248(1) definitions: “tax benefit” means a reduction, avoidance or deferral of tax or other amount payable under this Act or an increase in refund under this act. • Canada Trustco para 25: the Supreme Court adopted the House of Lords’ test for “series of transactions” as a number of transactions that are “pre-ordained in order to produce a given result” with “no practical likelihood that the pre-planned events would not take place in the order ordained. ” 67

A Tax Benefit Arising From a Transaction or Series of Transactions (cont’d) • Ibid A Tax Benefit Arising From a Transaction or Series of Transactions (cont’d) • Ibid at para 25: when a deduction is claimed, the existence of a tax benefit is clear. Where there is no deduction claimed, or where a benefit is otherwise unclear, the tax benefit can only be established by comparison with an alternative arrangement. 68

A Tax Benefit Arising From a Transaction or Series of Transactions (cont’d) • The A Tax Benefit Arising From a Transaction or Series of Transactions (cont’d) • The only case where a taxpayer was found not to have gained a benefit is Univar Canada Ltd. v. R (2005 TCC 723): – Judgment: • The Minister based its decision on an untrue hypothesis that inter-corporate debts had actually been purchased by the taxpayer rather than the subsidiary, and its alternative transaction was that the taxpayer purchased the debt directly • This was incorrect, the decision to have the subsidiary purchase the debt was a business decision made by the larger enterprise • The CRA could not recharacterize the transaction to make it something it was not 69

Avoidance Transaction • Canada Trustco para 22: An avoidance transaction is any transaction that Avoidance Transaction • Canada Trustco para 22: An avoidance transaction is any transaction that results in a tax benefit, either by itself or as part of a series of transactions, unless the transaction may be considered to have been undertaken or arranged primarily for a bona fide purpose other than to obtain the tax benefit. 70

Avoidance Transaction (cont’d) • Spruce Credit Union v. R, 2014 FCA 143: cont’d – Avoidance Transaction (cont’d) • Spruce Credit Union v. R, 2014 FCA 143: cont’d – Facts: • STAB and CUDIC were deposit insurance corporations funded primarily through assessments paid by BC credit unions, which were also members • A BC regulatory agency determined that CUDIC needed to increase its fund, which would require a further assessment of the credit unions. Primarily to assist them, STAB provided an inter-corporate dividend in a manner that allowed the taxpayer to both deduct that dividend and the assessment it provided to CUDIC • The Minister disallowed the dividend deduction on the basis of, inter alia, the GAAR 71

Avoidance Transaction (cont’d) • Spruce Credit Union v. R, 2014 FCA 143: cont’d – Avoidance Transaction (cont’d) • Spruce Credit Union v. R, 2014 FCA 143: cont’d – Judgment: • Although tax considerations may have played an important role, the choice of transactions was made for primarily nontax purposes, so there was no avoidance transaction • But the Court in Spruce affirmed that even if only one step in the entire transaction is taken for the purpose of avoiding tax, that will constitute an avoidance transaction 72

Misuse or Abuse • Canada Trustco at para 44: – The first task is Misuse or Abuse • Canada Trustco at para 44: – The first task is to interpret the provisions giving rise to the tax benefit to determine their object, spirit and purpose – The next task is to determine whether the transaction falls within or frustrates that purpose 73

Misuse or Abuse (cont’d) • Birchcliff Energy Ltd. v. R. , 2015 TCC 232 Misuse or Abuse (cont’d) • Birchcliff Energy Ltd. v. R. , 2015 TCC 232 – Facts: • Veracel incurred significant losses and ceased operating in 2002; it amalgamated with Birchcliff Ltd. to form the taxpayer in 2005 • The purpose of the transaction was to use Veracel’s losses • As part of the transaction, Veracel issued subscription receipts to investors on the basis of Birchcliff Ltd. ’s oil and gas business, which were then exchanged for common shares of the new corporation after the amalgamation • The Minister disallowed the deductions based on the losses on the basis that the taxpayer was barred from using losses because it circumvented loss streaming rules in the act by avoiding a special rule that deems control to have been acquired before the amalgamation, in contravention of the GAAR 74

Misuse or Abuse (cont’d) • Birchcliff Energy Ltd. v. R. , 2015 TCC 232 Misuse or Abuse (cont’d) • Birchcliff Energy Ltd. v. R. , 2015 TCC 232 • Judgment: • Section 256(7)(b)(iii) is a deeming provision that deems a corporation to have acquired control of a corporation it amalgamated with immediately before the amalgamation, unless – (B) if one person had immediately after the amalgamation acquired all the shares of the new corporation's capital stock that the shareholders of the predecessor corporation, or of another predecessor corporation that controlled the predecessor corporation, acquired on the amalgamation in consideration for their shares of the predecessor corporation or of the other predecessor corporation, as the case may be, the person would have acquired control of the new corporation as a result of the acquisition of those shares 75

Misuse or Abuse (cont’d) • Birchcliff Energy Ltd. v. R. , 2015 TCC 232 Misuse or Abuse (cont’d) • Birchcliff Energy Ltd. v. R. , 2015 TCC 232 – Judgment: cont’d • The investors were made investors for the sole purpose of artificially complying with this subsection • It was an effort to use the exception in s. 256(7)(b)(iii)(B) to circumvent the deeming rule in s. 256(7)(b)(iii) in a manner that did harm to the object, spirit and purpose of that section 76

Deans Knight Income Corp. v. The Queen, 2015 TCC 143 • Facts: – The Deans Knight Income Corp. v. The Queen, 2015 TCC 143 • Facts: – The taxpayer engaged in certain transactions in 2008 and 2009, and claimed certain non-capital losses, a terminal loss, and SR&ED expenditures – The CRA reassessed the appellant to deny the claimed amounts on the basis that they had been lost on the acquisition of control of the taxpayer, or on the basis of the GAAR – The taxpayer attempted to strike the GAAR pleading on the basis that it was “plain and obvious, assuming the facts to be true, that the pleading discloses no reasonable cause of action. 77

Deans Knight Income Corp. v. The Queen, 2015 TCC 143 (cont’d) • Judgment: – Deans Knight Income Corp. v. The Queen, 2015 TCC 143 (cont’d) • Judgment: – Since the “object, spirit and purpose” of each section of the Act has not been judicially determined, the judge found it very difficult to believe that it was plain and obvious that the Minister could not succeed on a GAAR argument in respect of a series of actions of a type that had not been previously ruled upon – By its very nature, “the misuse or abuse” test could only be determined after the detailed analysis that a trial permits 78

Applying the GAAR to international tax evasion and “treaty shopping” • Treaty shopping refers Applying the GAAR to international tax evasion and “treaty shopping” • Treaty shopping refers to the process of funneling corporate profits through low-tax jurisdictions with whom Canada has a tax treaty in order to reduce a final tax burden • ITA s. 245(4)(a)(iv): – The GAAR applies to avoidance transactions designed to take advantage of tax treaties 79

Applying the GAAR to international tax evasion and “treaty shopping” (cont’d) • S. 4. Applying the GAAR to international tax evasion and “treaty shopping” (cont’d) • S. 4. 1 of the Income Tax Conventions Interpretation Act: – “Notwithstanding the provisions of a convention or the Act giving the convention the force of law in Canada, it is hereby declared that the law of Canada is that section 245 of the Income Tax Act applies to any benefit provided under the convention” 80

MIL (Investments) S. A. v. R. , 2006 TCC 460 • Facts: – The MIL (Investments) S. A. v. R. , 2006 TCC 460 • Facts: – The taxpayer was incorporated in the Cayman Islands by a Canadian resident individual, who sold it his shares in DFR, a Canadian public company of which he was a director – Years later the taxpayer transferred a portion of its shares to an arm’s length purchaser, ensuring that it held less than 10% of the shares in DFR and deferring Canadian tax 81

MIL (Investments) S. A. v. R. , 2006 TCC 460 (cont’d) • Facts: cont’d MIL (Investments) S. A. v. R. , 2006 TCC 460 (cont’d) • Facts: cont’d – The taxpayer then continued in Luxembourg, a country with whom Canada has a tax treaty, and received a stepped up cost base in its remaining shares in DFR – It then sold the remainder of its shares in DFR, did not pay tax on any capital gains in Luxembourg and claimed an exemption from Canadian taxation under Article 13 of the Canada-Luxembourg Tax Convention 82

MIL (Investments) S. A. v. R. , 2006 TCC 460 (cont’d) • Judgment – MIL (Investments) S. A. v. R. , 2006 TCC 460 (cont’d) • Judgment – There was a bona fide non-tax purpose since the Canadian individual, while a director of DFR, could not have otherwise convinced the board of DFR to allow the sale 83

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