This article discusses the international aspects of amendments in Bill C-47 to Canada's Income Tax Act. This includes the expansion of withholding tax obligations for non-residents, narrowing of the money lending business exception, and the introduction of a new functional currency and broader stop-loss provision. These changes have compliance implications for middle-market taxpayers that conduct business across borders.
Bill C-47: International Tax Changes
Bill C-47 received royal assent on June 22, 2023. Arguably, the most widely discussed amendment to the Income Tax Act (Canada) (the Act) brought about by Bill C-47 is an expansion of the 'mandatory disclosure rules'. However, Bill C-47 also contains measures adopted by Parliament in the realm of international taxation that should not go unnoticed by middle-market taxpayers. This article addresses those key amendments.
Withholding tax obligations are expanded for non-resident’s that elect under section 216
In Canada, the withholding tax system mandates a 25 per cent income tax on payments from a Canadian resident to a non-resident for specific obligations. These obligations include various income categories, such as management fees, non-arms length interest and dividends. The responsibility for deducting and remitting the 25 per cent tax falls upon the payer, who is the Canadian resident making the payment to the non-resident.
The Act not only focuses on Canadian residents but also imposes a withholding tax obligation on non-residents that make specific payments to other non-residents. This withholding obligation applies when the payments are deductible against taxable income earned in Canada by the payer non-resident. The rationale behind this provision is that if a non-resident, who earns income from a source in Canada, can deduct the payments to another non-resident in computing Canadian taxable income, Canada's withholding tax system ought to apply to those payments as if the non-resident payer were a Canadian resident.
Before the introduction of Bill C-47, these rules did not cover situations where a non-resident individual made payments to another non-resident, that were deductible in earning Canadian-source rental income. This was the case regardless of whether the non-resident making the payments opted to be taxed based on their net rental income or their gross rental income.
The amendments (in force)
The previously mentioned deeming rule has been amended to capture scenarios where a non-resident individual calculates their rental income from Canadian-source property using a net approach and subsequently makes a payment to or credits an amount to another non-resident individual. This amendment has potential implications for taxpayers within the same corporate group, particularly when an unsecured interest-bearing loan is extended between non-resident entities to facilitate the acquisition of Canadian real estate. It is important to note that secured interest-bearing loans falling within this scope are subject to a separate provision.
The money lending business exception for the upstream loan rules and shareholder loans is narrowed
The Act includes provisions designed to prevent taxpayers from deferring tax payments by utilizing a loan from a foreign affiliate, referred to as an upstream loan, in lieu of dividend payments when repatriating funds to Canada. In essence, these provisions ensure that loans received from a foreign affiliate are accounted for as income in the year they are received by a Canadian corporation.
Prior to Bill C-47, there existed an exception to this requirement of including a foreign affiliate loan in a Canadian corporation's income. This exception applied when a loan was associated with a foreign affiliate's money lending business. This carve-out allowed certain loans to remain outside the scope of immediate income inclusion for the Canadian corporation’s taxable income calculations.
The amendments (in force)
Bill C-47 introduces a refinement to the money lending business exception by narrowing the scope of its application to cases where the foreign affiliate is predominantly involved in arm's length lending activities. To achieve this, the amendment excludes a business from the money lending exception if, during the period when an upstream loan is outstanding, less than 90 per cent of the total loan amount from the business is owed by borrowers who have an arm's length relationship with the creditor.
These changes mirror amendments made to the Act concerning shareholder loans extended to individuals (excluding corporations) from either domestic or foreign affiliate corporations.
A new functional currency and broader stop-loss provision
The Act allows Canadian resident corporations to report their Canadian tax results using a chosen functional currency, provided it qualifies as a qualifying currency as defined in the Act. Given that income tax consequences can arise from related parties operating with different functional currencies, the Act includes a safeguarding stop-loss rule provision to counter potential abuses of the functional currency tax reporting framework. For instance, if related corporations with different functional currencies engage in a transaction where the fluctuation of currency value causes one of these taxpayers to increase their loss, reduce their income, or a transformation of gains to losses, then the Act typically intervenes to prevent the recognition of that loss.
The amendments (in force)
The existing framework outlined above has been enhanced by the addition of a fifth 'qualifying currency,’ specifically Japan's currency. Additionally, a noteworthy amendment extends the scope of the stop-loss rule to encompass not only "related corporations" but also "related persons." This expanded term encompasses a range of entities, including individuals, corporations and tax-exempt organizations. This adjustment bears significance due to its implications for a wider array of transactions that now fall under the purview of the stop-loss rule.
Stay apprised of the less discussed changes to the Act
Given that amendments to the Act may introduce significant changes like the mandatory disclosure framework in Bill C-47, it is crucial for middle-market taxpayers to consider less-publicized amendments. Even seemingly minor adjustments to the Act have the potential to reshape a taxpayer's compliance obligations. The impact of international tax changes under Bill C-47 serves as a testament to this idea.