Year-end tax planner 2018: Key US & international tax updates
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U.S. Tax Reform
On November 2, 2017, the House of Representatives released the legislative text of H.R. 1, the “Tax Cuts and Jobs Act” or the “TCJA”. Over the next few weeks, the proposed legislation was marked-up by both the House and Senate. The House version of the legislation passed the House on November 16, 2017 and the Senate version passed the Senate on December 2, 2017. These versions went on to a committee conference where a unified bill would pass.
On December 22, 2017, the TCJA was signed into law by President Trump.
The TCJA permanently modifies business taxation, while most changes to individual taxation are generally set to expire after December 31, 2025. The Joint Committee on Taxation estimates that the net tax reduction will be approximately $1.4 trillion over the next ten years.
Among the numerous other provisions of the TCJA, the new law dramatically reduces corporate tax rates, moves to an effective territorial system of taxation for offshore business profits of domestic businesses, introduces a new concept of a reduced tax burden on pass-through business income, and limits business interest expense deductions.
Changes to federal tax rates – For U.S. C-Corporations with a tax year beginning after December 31, 2017, federal tax rates are reduced to a flat rate of 21 per cent. Prior to the TCJA, C-Corporations were subject to graduated tax rates, with the highest marginal federal corporate income tax rate being 35 per cent.
For U.S. citizen individuals, starting with the 2018 tax year, the top marginal federal tax rate is dropping to 37 per cent. Prior to tax reform, an individual’s top tax rate was 39.6 per cent.
South Dakota v. Wayfair U.S. Supreme Court decision
U.S. state and local tax nexus is most often addressed in the context of analyzing what a company does and determining where in the United States the company could arguably have established sufficient contacts to be required to file state income and franchise, sales and use, or gross receipts tax returns. However, the question of where a company has to file only scratches the surface of the importance of nexus.
On June 21, 2018, the U.S. Supreme Court issued its decision in South Dakota v. Wayfair, overturning the long-standing ’physical presence’ nexus standard established through Quill v. North Dakota in 1992. With the Wayfair decision, the Court has opened up the possibility for states to impose sales and use tax collection and remittance responsibilities on remote sellers based solely upon their economic presence in a state. This decision, and resulting changes to the sales and use tax nexus landscape, will have wide-ranging impacts on most taxpayers in most industries. Over half of the states have provided new laws or guidance in response to Wayfair through the early fall of 2018. It is anticipated that the decision will also impact how states approach income and franchise tax nexus.
All businesses selling inbound into the United States should remain observant of how the states they sell into react to the Wayfair decision. This decision does not only impact U.S. domestic entities, but also foreign entities, and new collection, remittance and reporting requirements can arise for those that have not done so historically.
U.S. Tax Reform 2.0
On November 26, 2018, the U.S. House of Representatives Committee on Ways and Means introduced the “Retirement, Savings, and Other Tax Relief Act” that would continue the House GOP’s tax reform efforts, commonly referred to as Tax Reform 2.0. This bill includes elements of earlier bills and includes several technical corrections to the TCJA, extends certain tax credits and other provisions, promotes retirement savings and includes provisions that make it easier for taxpayers to deduct more start-up and organizational costs. The House of Representatives may discuss the bill in the coming weeks, but neither chamber of Congress has passed the bill at the time of this writing.
Filing due dates
The filing due date for U.S. individual tax returns, U.S. corporate tax returns, and Report of Foreign Bank and Financial Accounts (FBAR) is April 15, 2019. U.S. partnership returns are due March 15, 2019. Taxpayers may be permitted to extend the filings of these returns and reports up to six months provided the appropriate extension form is filed.
Under the Foreign Investment in Real Property Tax Act of 1980 (FIRPTA), upon disposition of U.S. real property interests (USRPI) by a foreign individual or entity, the purchaser must withhold 15 per cent of the total sales price. There are exceptions to FIRPTA withholding.
The Foreign Account Tax Compliance Act (FATCA) is a U.S. federal law that requires U.S. persons, including individuals who live outside the United States, to report their financial accounts held outside of the United States. It also requires foreign financial institutions (FFIs) to report certain organizational and financial information to the Internal Revenue Service regarding their U.S. clients. Congress enacted FATCA to make it more difficult for U.S. taxpayers to conceal assets held in offshore accounts and shell corporations. Non-compliance could attract 30 per cent withholding taxes from all U.S.-sourced payments. Responsible officers of companies with FFIs in the group that are residents of countries with model 2 intergovernmental agreements in effect (such as Switzerland, Bermuda, or Japan) must certify their compliance with FATCA’s due diligence and anti-avoidance requirements by December 15, 2018 or they may be subject to 30 per cent withholding on certain U.S.-sourced payments that they receive.
Cross-border surplus stripping using partnerships and trusts
Under the existing rule, a non-resident shareholder is prevented from extracting a Canadian corporation’s surplus in excess of the paid-up capital (PUC) of it shares or to artificially increase the PUC of such shares. The result of this rule is a deemed dividend (subject to withholding tax of 25 per cent, which may be reduced under relevant tax treaties) to the non-resident or suppression of the PUC. To circumvent this rule, certain taxpayers have engaged in transactions that involve a transfer of the shares of a Canadian subject corporation by a non-resident to a partnership in exchange for an interest in the partnership and the partnership interest is then transferred to a Canadian purchaser corporation. Other transactions include variation of this partnership planning and similar planning involving trusts.
The 2018 Federal Budget proposes to amend these anti-surplus-stripping rules to add comprehensive ‘look-through’ rules for such entities. These rules will look through the partnership or trust to its members or beneficiaries, based on the relative fair market value of their interests. This measure will apply to transactions that occur on or after February 27, 2018.
Foreign affiliate - investment business (tracking arrangements)
Income from investment business carried on by a foreign affiliate of a Canadian taxpayer is generally included in the foreign affiliate’s foreign accrual property income (FAPI), unless certain exceptions are met. One of these exceptions is that the foreign affiliate employs more than five full-time employees (or the equivalent) in the active conduct of its business. Certain Canadian taxpayers whose foreign investment activities would not warrant more than five full-time employees have entered into arrangements with other taxpayers to meet the employee exemption noted above by pooling their financial assets in a common foreign affiliate. While the taxpayers take the position that the affiliate is carrying on a single business, their investment returns are tracked and determined separately by reference to the property contributed to the common affiliate.
The 2018 Federal Budget proposes to modify the investment business definition to address these arrangements and deem those activities to be separate businesses. Therefore, each separate business will need to satisfy each relevant condition in the investment business definition, including the more than five full-time employee test, in order for the affiliate income from that business to be considered active business income and excluded from FAPI. This measure will apply to taxation years of a taxpayer’s foreign affiliate that begin on or after February 27, 2018.
Controlled foreign affiliate status
The FAPI of a foreign affiliate of a taxpayer is included in the taxpayer’s income on an accrual basis only if it is a controlled foreign affiliate. To avoid such accrual taxation, certain Canadian taxpayers have used tracking arrangements similar to the ones mentioned above: since the group of taxpayers is sufficiently large, they do not have controlling interest in the affiliate.
The 2018 Federal Budget proposes to deem a foreign affiliate of a Canadian taxpayer to be a controlled foreign affiliate if the FAPI attributable to specific activities of the foreign affiliate accrues to the benefit of the taxpayer under a tracking arrangement. This measure is to ensure that each taxpayer involved in the tracking arrangement is subject to accrual taxation. This measure will apply to taxation years of a taxpayer’s foreign affiliate that begin on or after February 27, 2018.
Reassessment period involving a foreign affiliate
The normal reassessment period for taxpayers with foreign affiliates is four years after its initial assessment. A three-year extended reassessment period currently exists in respect of assessments made as a consequence of a transaction with a non-resident that the taxpayer does not deal at arm’s length. However, this extended period does not apply in all relevant circumstances. The 2018 Federal Budget further extends this rule by providing the CRA with an additional three years to reassess the prior taxation year of a taxpayer to the extent the reassessment relates to the adjustment of income by way of a loss carryback. This will apply where a reassessment is made as a consequence of a transaction involving a non-arm’s length non-resident person such that the loss in that subsequent year that was available for carryback to the prior taxation year is reduced. This will essentially provide the CRA with six years after the normal reassessment period to reassess the taxation year to which the loss was carried back in such circumstances. This measure will apply to losses carried back from a taxation year that ends on or after February 27, 2018
Reporting requirement of a foreign affiliate (Form T1134)
Canadian taxpayers are obligated to file information returns, Form T1134, for their foreign affiliates each year. Currently, these information forms are due 15 months after the corporation’s year-end. In the notice of ways and means motion (NWMM) that was released on October 25, 2018, it was proposed to shorten the filing deadline to 12 months for the tax year starting in 2020 and 10 months for tax years starting after 2020.
Loans with foreign corporations
There are complex rules associated with loans made from and to non-resident corporations and certain non-arm’s length persons. Therefore, it is highly recommended that a comprehensive review of the financing arrangements with related parties should be undertaken on a regular basis. Relevant tax implications should be carefully considered before implementing cross-border financing arrangements and a tax professional should be consulted whenever in doubt.
The thin capitalization rules were introduced to prevent the erosion of the Canadian tax base by restricting the deductibility of interest on the loan due to a specified non-resident shareholder (which is defined to be a shareholder who holds 25 per cent or more of the issued shares or the fair market value of the shares of a Canadian corporation) and if the amount of the outstanding debts to specified non-residents exceeds 1.5 times the Canadian resident corporation’s equity amount. The result of the rules is that the interest expense that exceeds the debt-to-equity ratio limit is not deductible and such amount is also considered to be a deemed dividend, subject to applicable withholding taxes.
Back-to-back (B2B) rules
If an intermediary is set up in a foreign jurisdiction that is subject to lower or no withholding tax, such arrangement may be caught by the B2B rules. It would look up to the ultimate funder of such arrangement and apply a greater withholding tax rate. Recent changes in the legislation had made this rule even broader to capture leasing and licensing arrangements as well as shareholder loans.
Upstream loan rules
A loan made from a foreign affiliate to a Canadian taxpayer or a related person (except for certain controlled foreign affiliates) is subject to the upstream loan rules if the loan will not be repaid within two years of the day the loan was made. As a result, the principal amount of the loan is included in income of the Canadian taxpayer in the year the loan was made. If the foreign affiliate and its subsidiaries has sufficient tax attributes, the Canadian taxpayer would be able to claim a deduction to offset the income inclusion as if a hypothetical dividend was paid by the foreign affiliate to the Canadian taxpayer. However, the same tax attributes that are used to offset income inclusion will not be available to support dividends paid from the same foreign affiliates.
Loan receivable due from a non-resident corporation
Where a Canadian resident corporation lends money to a non-resident at no interest or less than ’reasonable’ interest and the loan is outstanding for more than a year, the Canadian resident corporation is deemed to have received interest income on the loan computed at a prescribed rate.
If a loan is made from a Canadian resident corporation to its non-resident parent or related non-resident companies, the entire outstanding balance is deemed to be a dividend for the purpose of imposing withholding tax. If this rule applies, there is no annual deemed interest inclusion. The Canadian corporation can elect out of the deemed dividend by making a pertinent loan or indebtedness (PLOI) election which requires that the Canadian corporation includes interest income on the loan at the prescribed rate. Loans made by, or to, certain partnerships may also be eligible for the election.
A non-resident corporation earning income or capital gains from Canada may set up a company in a third jurisdiction which has a more generous tax treaty with Canada. This arrangement of minimizing tax liability is referred to as treaty-shopping. As CRA continues to contemplate the application of General Anti-Avoidance Rules to treaty-shopping arrangements, it is essential for non-resident investors to carefully consider their financial models and avoid being caught under such measures.
Foreign and non-resident information returns
- Canadian resident taxpayers must file Form T1135 when the cost amount of their foreign property exceeds $100,000 at any time during the year.
- Corporations must report their non-arm’s length activities with non-residents on Form 106 if the total amount of such transactions exceeds $1,000,000.
- Both forms mentioned above are due the same time as the tax return, and any late filing or non-filing will result in substantial penalties and charges.
- Canadian taxpayers that own shares of a non-resident corporation that is a foreign affiliate in the year must file Form T1134. A Form T1134 is not required if the total cost amount of the interest in all foreign affiliates was less than $100,000 AND the foreign affiliate is "dormant" or "inactive" for the affiliate's taxation year ending in your taxation year. Currently, the form is due 15 months after the Canadian corporation’s year-end. It was proposed that the filing deadline would be shortened to 12 months for the ax year starting in 2020 and 10 months for tax years starting after 2020.
Payments to non-residents
- Withholding tax at 25 per cent applies to interests (other than interest paid to arm’s length non-residents), dividends, rents, royalties, certain management and technical service fees and similar payments made to non-residents. The rate of withholding tax can be reduced under relevant tax treaties.
- Non-residents may file forms NR301, NR302 and NR303 to support that the non-resident is eligible for the reduced withholding tax rates on payments under a tax treaty.
Regulation 105 – payments to non-resident for services rendered in Canada
This regulation requires every taxpayer paying to a non-resident person fees, commissions, or other amounts for services rendered in Canada, to withhold and remit 15 per cent to CRA, where the remittance is due on the 15th day of the month preceding to the month which the fee was paid. In Quebec, an additional 9 per cent withholding tax rate applies. However, the regulation does not apply to certain reimbursements.
A non-resident may apply to a regulation 105 waiver if the non-resident is a resident of a treaty country with Canada and does not carry on business through a permanent establishment in Canada.
Regulation 102 – source deduction rules
Remuneration that is paid to non-resident employees for work performed in Canada is subject to tax in Canada, unless the non-resident employee is exempt under the relevant tax treaties. Under most treaties, many of these workers would not have had to pay tax in Canada, when the number of days or the amount of Canadian-source income is below the threshold as stated in the respective treaties.
Non-resident employers who send employees to work in Canada are required to withhold and remit taxes under Reg. 102 for Canadian-source income to the CRA, unless a waiver of withholding tax (Form R102-R, Regulation 102 Waiver Application) is completed and filed with the CRA 30 days either before the start of the employment services in Canada or the initial payment for the employment services.
Regulation 102 –Certification option
Non-resident employers, who apply for the non-resident employer certification, will not have to withhold and remit tax from salary, wages and other remuneration that the employer pays to non-resident employees (if certain requirements are met, as explained below). Accordingly, this will eliminate the need for the non-resident employers/employees to request a Reg. 102 waiver of withholding, where applicable. The non-resident employer certification will be valid for up to two calendar years. Below are the requirements and relevant registration information for both employers and employees.
Employers (“qualified non-resident employer”)
- At the time of the payment, the non-resident employer must be resident in a country that Canada has a tax treaty with; and
- The non-resident employer is certified by the Minister of National Revenue under subsection 153(7) of the Act.
To apply for a certification, the non-resident employer has to file Form RC473 – Application for Non-Resident Employer Certification and send it for CRA’s approval. This application must be submitted at least 30 days before the qualifying non-resident employee starts to provide services in Canada.
Employees (“qualifying non-resident employee”):
- A resident in a country that Canada has a tax treaty at the time of the payment;
- Not liable to pay tax under Part I of the Canadian Income Tax Act on the payment because of treaty exemption; and
- Works in Canada for less than 45 days in the calendar year that includes the time of the payment, or is present in Canada for less than 90 days in any 12-month period that includes the time of the payment.
The non-resident employer has to make sure that the employee is eligible under the certification.
Disposition of taxable Canadian property
When non-residents dispose of their taxable Canadian property (TCP), such as real estate, interest in partnerships or trusts and shares of some corporations that own substantial real estate, they are liable to report and pay tax on the gains or income from the sales. The buyer is liable to withhold tax from the gross amount of the sale and remit the tax within 30 days from the end of the month in which the sale occurred. Exemptions apply when a clearance certificate is obtained or when there was no reason to believe that the vendor was not a resident of Canada after reasonable inquiry. The tax may be reduced under the tax treaty between Canada and the non-residents’ home countries.
If a Canadian corporation has transactions with its related non-resident corporation or partnership, the corresponding transfer pricing documentation needs to comply with the standards established by the Canadian transfer pricing rules and that of any foreign jurisdiction. There could be significant penalties if the transfer prices or cost allocation do not reflect arm’s length terms and conditions. The Canadian transfer pricing legislation and administrative position are generally in line with the guidelines of the Organization for Economic Co-operation and Development (OECD). Given the recent changes in the development of the guidelines by the OECD, it is likely that there will be corresponding amendments in the Canadian context.