2021 IFA CANADA TAX CONFERENCE
MAY 4 – 5, 2021
YIN RAPPORTEUR REPORTS
▼ Budget 2021 and Other Canadian Law Developments
▼ Tax Directors Roundtable: Managing Tax Risk in Uncertain Times
▼ Cross-Border M&A Update
▼ OECD and International Developments
▼ Current Cases – Selected Case Review
Budget 2021 and Other Canadian Law Developments
YIN Rapporteur: Megan Seto, Deloitte LLP, Toronto
May 4, 2021
This panel discussion focused on recent developments in Canadian taxation. In particular,
panelists discussed a recent Canada Revenue Agency (“CRA”) tax ruling regarding the continuation of losses into Canada and the use of losses, and the Canadian government’s 2021 Budget pertaining to:
- mandatory disclosure rules;
- interest deductibility limitation;
- hybrid mismatch arrangements;
- digital services tax; and
- transfer pricing reform.
Please note that at the time that the panel discussion was held, no draft legislation was included in the 2021 Budget materials.
- Continuation Tax Ruling – 2019 – 0819871R3
The CRA was asked to provide a ruling regarding whether USCo still had non-capital losses from its Canadian branch business after a series of steps that included, amongst other steps, the continuance of USCo from a US state to a Canadian province. The transaction steps detailed in the ruling included the following:
- Step 1: USCo continued from one US state to another;
- Step 2: USCo then continued to a province of Canada as an unlimited liability company;
- Step 3: Shares of USCo were transferred to “ForeignCo2;”
- Step 4: USCo then converted to a regular corporation and then continued under the Canada Business Corporations Act (Canada) (“CBCA”); and
- Step 5: USCo and a related CBCA entity, “Canco,” amalgamated to form “Amalco.”
The CRA concluded that USCo was the same corporation both before and after the continuances. In this case, Amalco was permitted to use USCo’s non-capital losses given the losses were from carrying on a business in Canada which was not a treaty-protected business. Although section 128.1 of the Income Tax Act (Canada)(the “Act”) addresses a prescribed set of circumstances concerning the tax implications of corporate immigration to Canada, nothing in the provision limits the ability of USCo to use losses from its Canadian branch business. For further reading, the facts of this ruling and the detailed transaction steps were similar to those described in the Federal Court of Appeal decision, Merali.
- Canadian Federal Budget
- Mandatory Disclosure Rules
The 2021 Federal Budget introduced three significant changes to reporting requirements concerning Canada’s mandatory disclosure rules. The Government announced the expanded scope of the existing reportable transaction rules under section 237.3 of the Act and added two mandatory disclosure rules concerning certain listed transactions (i.e., a new category of “transactions requiring notification”) and uncertain tax treatments (i.e., a reserve) applicable to certain large corporate taxpayers. The Department of Finance is engaging in a public consultation in respect of draft legislation to improve the mandatory disclosure rules (firstname.lastname@example.org), and comments are requested by September 2021.
The reporting rules that apply to tax years are expected to apply to tax years that begin after 2021. In the case of reporting rules that apply to transactions, the reporting rules apply to transactions that occur after January 1, 2022.
- Interest Deductibility Limitation
The Government will release draft legislation in summer 2021 outlining additional limitations on interest deductibility that target cross-border base erosion. The measures target cross-border interest, interest on borrowing to earn tax-exempt income, and interest borne disproportionately by Canadian entities of a multinational group. The rules are not intended to target common loss utilization planning arrangements and Canadian corporate groups without a non-resident member.
The limitation is applied on an entity-by-entity basis and will limit net interest expense deductions to the greater of:
- an entity’s percentage of “tax EBITDA,” or
- a “group ratio.”
Any denied interest would be subject to carryback and carryforward rules. The proposed rules introduce greater complexity to cross-border financing structures without modifying existing measures such as the thin-capitalization, foreign affiliate dumping or back-to-back-loan rules.
- Hybrid Mismatch Arrangements
Cross-border payments in respect of financial instruments that result in a “deduction/non-inclusion” (“D/NI”) outcome are addressed in a set of measures targeting “hybrid mismatch arrangements.” A hybrid mismatch arrangement resulting in a D/NI outcome refers to mismatches arising where a deduction may be claimed in respect of a cross-border payment by the payor in one country, while the recipient of the payment is not required to include the payment in the computation of its income within a reasonable time. The new measures include primary and secondary rules and apply to payments made to a related person or where the payment is made under a structured arrangement.
The Government will release two separate legislative packages to implement the new rules beginning in 2021.
- Digital Services Tax
The Government announced an interim measure to implement a digital services tax (“DST”) after delays in reaching a multilateral agreement to taxing digital businesses without a physical presence. The tax is intended to ensure that revenue earned by large multinational businesses from engagement with Canadian online users is subject to Canadian tax. The DST is a 3% tax based on revenue earned from certain services that have Canadian users. DST legislation is expected this summer and is effective as of January 1, 2022.
- Transfer Pricing Reform
As a consequence of perceived inadequacies with Canada’s transfer pricing rules after the decision in Her Majesty the Queen v Cameco Corporation, 2020 FCA 112, leave to appeal to SCC denied, the Department of Finance will be seeking consultation regarding Canada’s transfer pricing rules “with a view to protecting the integrity of the tax system while preserving Canada’s attractiveness as a destination for new investment and business activity.” Further information from the Department of Finance is anticipated.
In the Tax Directors Roundtable, “Managing Tax Risk in Uncertain Times“, moderated by Matthew MacInnis (Manulife Financial) and with the participation of Cheryl Bailey (Sun Life Financial), Lara Friedlander (CIBC), and Michael Munoz (Suncor Energy Services), several topics of interest were discussed, including:
- Operational risk and the COVID lockdown experience: the speakers discussed how the tax teams have adapted to the “new normal”, the “hiccups” and impact on certain types of tasks, remote onboarding, and the key positive takeaways that will (hopefully) remain in the long-term.
- The legislative volatility – navigating compliance in a future that is bringing material, frequent and rapid changes: the panelists gave their views on why we are living through a truly unique time as regards tax policy, significance of “change in law risk”, its impact on long-term planning and the necessity to be conservative, as well as the importance of managing internally expectations on the new high-level tax proposals and modelling (before draft legislation is available with details and they are in force).
- Compliance and assessment risk – dealing with heightened tax audit environment and its knock-on effects: the tax directors detailed their recent experiences on CRA audits, highlighted the challenge of allocating enough resources to attend CRA requests in a timely manner, especially given the increase on demands as well as the time-intensive nature of data gathering and the dependence on the input from other functions.
- 2021 Federal Budget: the presenters discussed the budget tax measures that specially caught their attention and highlighted the fact that most international proposals need to be further developed (announced consultation, draft legislation) so not many details yet are available on how exactly they would apply to their specific business; and remarked on the important role of industry associations on this front.
The panelists provided an overview of recent income tax considerations and trends relevant to inbound and outbound mergers and acquisitions (“M&A”).
Selected Tax Treaty & International Developments
In May 2020, the Canada Revenue Agency (“CRA”) provided specific guidance surrounding corporate tax residency tests/thresholds in light of the travel restriction raised by the COVID-19 crisis. The CRA guidance was mostly effective up to September 30, 2020, resulting in uncertainties surrounding the application of the rules in 2021 and onwards, considering the ongoing travel restrictions in Canada and elsewhere. One other item of interest is the recent introduction of the sixth version of the European Union Directive on Administrative Cooperation (DAC 6) which adds a layer of statutory reporting in the context of international M&A transactions involving certain European jurisdictions. Finally, cross-border M&A will be affected by the Multilateral Instrument (MLI) applicable to the Canadian tax treaty network and further guidance is awaited from the CRA on the application/interpretation of the principal purpose test and to the amended tax treaty preamble (amongst others).
M&A Current Trends
The current M&A transaction trends include Canadian companies going public by merging with a special purpose acquisition company (“SPAC”). A SPAC transaction can be structured in various ways but should be subject to careful tax planning with a specific focus on the sequencing of the steps leading to the merger between the SPAC and the Canadian target corporation. Another important tool currently used by tax practitioners in structuring cross-border transactions is the so-called exchangeable shares structure in both the inbound and outbound M&A context which could provide, respectively, for a tax-deferral applicable to Canadian rollover sellers and certain cash repatriation flexibility relating to Canadian dividends withholding tax.
Selected 2021 Budget Proposals
The Canadian Federal Budget released on April 19, 2021 proposed new rules that could affect certain leveraged acquisitions with the introduction of interest deductibility limits based on taxable income before interest, tax, depreciation and amortization (i.e., tax EBITDA). Further, some of the tax benefits historically available by relying on hybrid financing instruments and/or dual-resident entities could be targeted by the new proposed rules aimed at hybrid mismatch arrangements. Finally, the consultation launched by the CRA on the updated and increased mandatory disclosure could cause taxpayers to be required to notify the CRA of certain M&A transactions and uncertain tax positions (amongst others).
The “OECD and International Developments” panel of the Canada IFA International Tax Conference featured Sophie Chatel, Head of the Tax Treaty Unit, OECD, Marja de Best, partner, Loyens & Loeff, Manuel de los Santos, Advisor-CTPA, OECD, Dominic Robertson, partner, Slaughter and May, as speakers and Lynn Moen, Director of Tax, Enbridge Inc., as moderator.
After introducing the speakers, Ms. Moen underlined that Ms. Chatel and Mr. de los Santos are limited in their comments on the current negotiation at the OECD/G20 Inclusive Framework on the tax challenges of the digitalization of the economy, and may not take questions on the current state of play.
The panel members talked about the high level of activity on taxation of digital services in the past year, including the publication of the OECD/G20 Inclusive Framework’s Reports on Pillars One and Two in October 2020 followed by public consultations in January 2021, the letter from US Treasury Secretary Janet Yellen to fellow G20 finance ministers in February 2021, and the forthcoming meeting of the G20 finance ministers in July 2021. The panelists also walked through developments in the EU and the UK aimed at enhancing transparency (DAC6 and public CbCR), transfer pricing developments, experiences with digital service taxes (DSTs) and levies as well as concerns around taxing rights.
Ms. Chatel and Mr. de los Santos provided an update on Pillars One and Two, as well as an overview of the Blueprints. They underlined the themes emerging from the consultations on Pillar One as broad support for an international consensus-based solution, convergence on a multi-national-enterprise approach, and calls for greater simplification. They also mentioned that certain non-governmental organizations expressed a desire for a broader scope and a focus on the amount of taxes recoverable by impacted jurisdictions.
Ms. de Best pointed out that the EU supports a global solution at OECD and supports the two pillars, but that it plans to move ahead with its own proposals if there is no consensus by June 2021. She also pointed out that an EU digital levy will be proposed, independent from the OECD Pillar One outcome.
Ms. Chatel and Mr. de los Santos delved into the OECD’s publications on special considerations arising from the COVID-19 pandemic, specifically on transfer pricing as well as global mobility of workers.
Ms. de Best addressed the aftermath of the Danish cases. She noted that the Netherlands is currently conducting consultations on proposed legislation which will enter into effect in 2022, aiming to combat transfer pricing mismatches as well as aligning classification rules with international standards to reduce hybrid entity mismatches.
Mr. Robertson provided an overview of certain impacts of BREXIT from a tax perspective, underlining key provisions of the UK-EU Trade Agreement, the impact on UK-EU dividends, interests and royalties, the application of DAC6, as well as the degree to which EU rules will continue to be relevant in the UK tax landscape.
This session involved a review of significant current case law in the following categories: (i) pending cases at the Supreme Court of Canada (“SCC”), (ii) cases dealing with residency, (iii) cases dealing with the General Anti-Avoidance Rule (or “GAAR”), (iv) other cross-border cases, and (v) administrative/procedural cases primarily dealing with requirements for information.
Pending SCC cases include R v Alta Energy Luxembourg SARL (“Alta”), which is under reserve, R v Loblaw Financial Holdings Inc v R (“Loblaw”), the hearing in which will proceed next week, and AGC et el at v Collins Family Trust et al (“Collins”), in which leave was recently granted. In Alta Luxembourg, the SCC will comment on whether the Crown’s position regarding beneficial ownership is tenable without legislative amendment. In Loblaw, the SCC is likely to focus on the inflow and outflows of funds in the context of the foreign affiliate property regime, and we will hear the perspectives of two very different intervenors (the Attorney General of Ontario and the Canadian Bankers’ Association). Finally, in Collins, the SCC will consider a case in which a taxpayer pursued rescission when the position of the Canada Revenue Agency (CRA) changed following a decision of the Courts.
The panel considered two residency cases: Landbouwbedrijf Backx BV v R, 2021 TCC 2 (“Backx”), and R v Development Securities PLC (“Development Securities”),  EWCA Civ 1750. The takeaway from Backx is that taxpayers must navigate procedural and substantial issues under Canadian law even when relying on relief given by tax treaties. Guidance from Development Securities – an English case – suggests that directors should be entrusted with the independence needed for decision-making for the central control and management test to be met.
Cases involving the GAAR included R v Bank of Montreal, 2020 FC 82 (“BMO”), Rogers Enterprises (2015) Inc v R, 2020 TCC 92 (“Rogers”), and Damis Properties Inc v R, 2021 TCC 24 (“Damis”, currently under appeal). The takeaway from all of these cases is that taxpayers should be careful about conceding portions of arguments – for example, with respect to tax benefit – without considering the full consequences.
Other international cases included Emergis v R, 2021 TCC 23 (“Emergis”) and Pangaea One Acquisition Holdings XII SARL v R, 2020 FCA 21 (“Pangaea”). Both of these cases involved the strict interpretation of ambiguous wording in the legislation, specifically the terms “in respect of” and “affect”.
Finally, the panel considered procedural cases including Bayer Inc v Attorney General of Canada, 2020 FC 750 (“Bayer”), Ghermezian v AGC, 2020 FC 1137 (“Ghermezian”), and Societe de fiducie Blue Bridge Inc c Canada (Revenu National), 2021 CAF 62 (“Blue Bridge”). Bayer dealt with foreign compliance orders, while Ghermezian and Blue Bridge dealt with domestic orders. While the taxpayer in Bayer successfully argued that the foreign order – issued after compliance with a domestic order – should be narrowed, Ghermezian and Blue Bridge appear to indicate that broad information seeking can be part of a proper exercise of CRA authority.
Our panel concluded with the observation that high-profile cases in which the CRA has been unsuccessful have spurred legislative amendment, including in the recent budget. The trend to transparency continues and more requests for taxpayer information should be anticipated.