The Budget has only 1 proposed income tax change in the area of international tax. This relates to foreign branches of Canadian resident life insurers. As such, the proposed change is not applicable, and probably not of interest to, most taxpayers. This minor tweaking of the international tax rules in the Tax Act by the Budget is in stark contrast to the extensive changes we have seen in this area over the past 10 years or so (e.g. the elimination and reduction of withholding taxes, broader thin capitalization rules, foreign affiliate dumping, anti-hybrid rules in the Canada – U.S. Tax Convention, foreign affiliate changes).
The Budget also reiterates Canada’s commitment to the Organisation for Economic Co-operation and Development (“OECD”)/G20 Base Erosion and Profit Shifting Project and notes specific steps taken by Canada in this regard.
Foreign Branches of Canadian Life Insurers
Unlike other taxpayers, a Canadian life insurer is generally not taxable in Canada on its worldwide income. Life insurers are generally subject to a special tax regime in section 138 of the Tax Act. Under section 138, a Canadian life insurer is generally taxable in Canada on income from carrying on its insurance business in Canada and is generally not taxable in Canada on insurance income from a foreign branch.
The Budget proposes to amend the Tax Act to apply a concept from the foreign accrual property income (“FAPI”) rules to Canadian resident life insurers with foreign insurance business operations. The proposed change will align the taxation of income from the insurance of Canadian risks earned in the foreign business of a Canadian life insurer with the tax treatment of this type of income under the FAPI regime when earned by a controlled foreign affiliate of a Canadian taxpayer.
FAPI of a controlled foreign affiliate of a Canadian resident is generally included in the Canadian resident’s income annually, whether or not the controlled foreign affiliate distributes its income to the Canadian resident. The FAPI regime is designed to prevent the deferral or reduction of Canadian tax by way of earning certain types of income in a controlled foreign affiliate in a low tax jurisdiction.
The FAPI rules apply to passive investment income and certain other types of income which are subject to specific rules. Income of a controlled foreign affiliate from the insurance or reinsurance of specified Canadian risks (e.g. a Canadian resident person, property in Canada, a business carried on in Canada) for a year will be FAPI unless more than 90% of the controlled foreign affiliate’s gross premium revenue (net of reinsurance ceded) for the year is in respect of the insurance of non-Canadian risks of persons with whom the controlled foreign affiliate deals at arm’s length. Income of a controlled foreign affiliate from ceding specified Canadian risks will also be FAPI. The Tax Act contains a supporting anti-avoidance rule which can apply to deem insurance income from certain swap arrangements to be income from the insurance of Canadian risks and hence FAPI.
Prior to the Budget, the FAPI rule for income from the insurance of Canadian risks described above did not apply to insurance income of the foreign branch of a Canadian life insurer.
The Budget will amend section 138 of the Tax Act to provide that income from insuring or reinsuring specified Canadian risks (e.g. a Canadian resident person, property in Canada, a business carried on in Canada) earned by a Canadian resident life insurer in a taxation year from a business carried on in a foreign country will be taxable in Canada, unless more than 90%
of the foreign business’ gross premium revenue (net of reinsurance ceded) for that year is in respect of the insurance of non-Canadian risks of persons with whom the Canadian resident life insurer deals at arm’s length. Income earned by a Canadian resident life insurer from ceding specified Canadian risks will also be taxable in Canada under the proposed amendments to section 138.
The anti-avoidance rule for swaps found in the FAPI rules will be replicated in section 138 for swap agreements or arrangements entered into by the Canadian resident life insurer, non-arm’s length life insurers resident in Canada, partnerships of which either the life insurer is a member, a foreign affiliate of the particular life insurer or a non-arm’s length person and a partnership of which such foreign affiliate is a member. In addition, an anti-avoidance rule will apply if a life insurer resident in Canada insures a foreign risk through its foreign branch and it can reasonably be concluded that the risk was insured as part of a transaction or series of transactions one of the purposes of which is to avoid the new rules.
These measures will apply to taxation years of Canadian taxpayers beginning on or after Budget Day.
Canada’s Actions Under BEPS
In the Budget, the Federal Government confirmed its commitment to protecting the Canadian tax base by implementing measures to address base erosion and profit shifting (“BEPS”). Generally, BEPS is the term used by the OECD to refer to international tax planning used by multinational enterprises (“MNEs”) which the OECD thinks minimizes taxes unfairly.
The Budget confirmed that the Federal Government has implemented, or is in the process of implementing, the following BEPS-related measures:
Section 233.8 of the Tax Act, which was introduced in December 2016, implements country-by-country (“CBC”) reporting in Canada. In general, pursuant to section 233.8 of the Tax Act, the “ultimate parent entity” (if a Canadian resident) of an MNE group with €750,000,000 or more of consolidated annual revenues is required to file a CBC report with the Minister within 1 year of its fiscal year-end. The CBC reporting requirements may also apply in circumstances where the MNE’s “ultimate parent entity” is not resident in Canada.
Information required to be provided in the CBC report includes a country-by-country allocation of: (i) revenue; (ii) profit; (iii) tax paid; (iv) stated capital; (v) accumulated earnings; (vi) number of employees; (vii) tangible assets; and (viii) the main activities of subsidiaries. The CBC reporting requirement applies for fiscal years of MNEs that begin after 2015.
Canada, together with more than 100 other jurisdictions, participated in the negotiation and development of the OECD’s multilateral instrument. The multilateral instrument is a tax treaty that can be signed by several countries that will operate to modify the provisions of existing bilateral tax treaties of those countries without the need for separate bilateral negotiations. The multilateral instrument addresses BEPS initiatives related to hybrid mismatches, treaty abuse, and avoidance of permanent establishment status, as well as dispute resolution and arbitration.
The multilateral instrument was open for signature as of December 31, 2016, and a first high-level signing ceremony is expected to take place in June 2017. In the Budget, the Federal
Government confirmed that it is pursuing the signature of the multilateral instrument by Canada and is undertaking the necessary domestic processes to do so. The multilateral instrument will enter into force after 5 countries have ratified it and will apply to specific tax treaties after all contracting parties have ratified it and a certain period of time has passed.
Spontaneous Exchange of Information/ Common Reporting Standard
The Budget confirms that the Canada Revenue Agency (the “CRA”) has begun the spontaneous exchange of tax rulings that could otherwise give rise to BEPS concerns with other tax administrations. The Budget states that the purpose of this practice is to ensure that revenue authorities are not granting non-transparent “private” rulings to taxpayers which guarantee favorable tax treatment with respect to particular transactions.
The Budget also states that the Federal Government is strengthening efforts to combat international tax evasion through enhanced sharing of information between tax authorities.
Part XIX of the Tax Act, which will come into force on July 1, 2017, implements the common reporting standard developed by the OECD. The common reporting standard is a standard for the automatic exchange of financial account information. To date, more than 100 jurisdictions have committed to implement the standard.
Under Part XIX of the Tax Act, Canadian financial institutions will be required to provide the CRA with information regarding certain accounts, including: (i) identifying information relating to the account holder; (ii) account balances; and (iii) certain amounts paid or credited to the account.
Of note, Canada’s existing bilateral tax treaties and tax information exchange agreements already provide for the exchange of information between Canadian tax authorities and other international tax authorities. Since such information sharing generally occurs without the requirement to obtain taxpayer consent or provide notice to the taxpayer, the trend towards increased information sharing may lead to controversy in the future.