Lawyers fear new Canadian tax rule could scare ... - Financial Post

All is not quiet on the Western Canadian tax front.

The Conservative federal government has enshrined into law a controversial policy that could dissuade foreign owned resource companies from establishing mining and energy subsidiaries in Canada, corporate tax lawyers say.

The new law is a response to something called ?foreign affiliate dumping? transactions. The federal government is concerned that Canada?s corporate tax base is being eroded by the technique. Finance Minister Jim Flaherty announced a plan to clamp down on the potential loss of tax revenue in the federal budget that was unveiled on March 29, 2012. That plan was controversial enough, yet corporate tax lawyers believe the version of the policy that was passed into the Income Tax Act earlier this year goes way beyond the ?mischief? the new rule is supposed to address.

?The proposals go much beyond that particular mischief and entail virtually any foreign controlled Canadian company acquiring shares of a so-called foreign affiliate,? says Bruce Sinclair, a chartered accountant who works with the law firm of Blake, Cassels & Graydon LLP.

The inflexibility of the new tax policy will send foreign companies to other jurisdictions, tax lawyers say.

?The consequence of the rule being so broad is that it potentially discourages activity that would otherwise be coming to Canada ? which is all ?found money? and which does not represent the risk of base erosion,? adds Steve Suarez, a partner in the Toronto office of Borden Ladner Gervais LLP. ?The real danger is that the companies never come here in the first place.?

?It?s not likely that foreign owned Canadian companies are going to put their money down into their foreign affiliates. They?re going to try to find a way for the foreign parent to structure through a different country, rather than Canada,? adds Jennifer Hanna, a tax lawyer in the Calgary office of Gowling Lafleur Henderson LLP.

Here?s how foreign affiliate dumping works. Foreign parent companies establish a Canadian subsidiary, then use that Canadian subsidiary to serve as the legal owner of a portfolio of properties from around the world.

Here?s the problem ? or to use the word favoured by tax experts ? the mischief. Canada?s tax rules used to allow a foreign parent company to ?loan? to the Canadian subsidiary the money that would be used to buy those various global properties. Profits generated from those global assets would flow into coffers of the Canadian subsidiary. Any profits that would then be passed up the chain to the foreign parent would be described as ?interest? payments on the loan rather than a dividend. That skirted around a Canadian rule that requires companies to remit withholding tax on dividend payments.

The system created possibilities for abuse, and tax lawyers understood why the government felt the need to plug the apparent loophole. Still, the initial policy shocked a lot of tax lawyers, who immediately saw that it might prevent foreign companies from investing in Canadian subsidiaries. Tax lawyers raised the issue with officials from the Department of Finance, and some technical changes were made as the policy was developed.

However, the resulting tax law, which entered into force this year, continues to trouble tax lawyers. They believe the federal government?s new law is far broader than it needs to be to close the loophole. As a result, the new law will capture a lot of corporate structures in which a foreign-owned Canadian subsidiary is managing a bundle of assets for reasons other than tax avoidance.

?The transactions they are trying to stop are clearly abusive and erode the Canadian tax base, so the rules do address an important problem,? says Alan Rautenberg of Bennett Jones LLP in Calgary. ?However, there doesn?t seem to be a lot of desire for a more careful targeting of these kinds of rules.?

Historically, foreign natural resource companies have viewed Canada as a great jurisdiction to domicile a mining or energy division. Canada?s two main stock exchanges, the Toronto Stock Exchange and the TSX Venture Exchange, are globally regarded as the best places in the world to raise capital for mining and energy ventures, particularly those at the exploration stage. Foreign investors also appreciate the technical and financial expertise that is available in Canada for resource projects.

An earlier version of the policy would have provided relief to those foreign owned subsidiaries who have chosen to base themselves in Canada for reasons other than tax avoidance, a so-called ?business purpose? exemption. Yet the version of the policy that has been passed into the tax act creates a much more limited exemption, the ?closely connected to Canada? test.?

?It?s fair to say that most tax advisors believe that the way that this exception has been worded is very narrow, and it will be very challenging for subsidiaries to be able to meet that test,? Mr. Sinclair says.

Financial Post

Source: http://business.financialpost.com/2013/05/22/lawyers-fear-new-canadian-tax-rule-could-scare-away-foreign-companies/

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