foreign affiliate is resident in a country listed
in the income tax regulations as a designate country
with a tax treaty in force with Canada.
are paid out of the foreign affiliate's "exempt
"Exempt surplus" is defined as:
from active business activities carried out from the
affiliate's permanent establishment. (Thus interest
earned from the deposit of funds in a bank account
does not come within the definition of exempt surplus.)
received by the foreign affiliate from the exempt
surplus of other affiliates.
dividends remitted to a Canadian parent by an Irish
affiliate which manufactures goods for export to the
UK market and which enjoys a tax holiday under Irish
laws will not be taxed in the hands of the Canadian
corporate entity. (N.B. A characteristic of double taxation
treaties is to define certain categories of income as
exempt surplus income which qualifies for tax free repatriation).
2007 had this to say with regard to the exempt surplus
its mismatch with interest deductibility has been a
long-standing problem, the 'exempt surplus' rule in
itself is a key competitive advantage of the Canadian
tax system. The rule allows a Canadian company to earn
business income through a foreign affiliate in any tax-treaty
country, and bring that income back to Canada, with
no Canadian tax. Since the only tax on this business
income will be that paid to the foreign country in which
it is earned, the system ensures that Canadian firms
are able to operate on a level playing field with their
the proposal above to resolve the interest deductibility
problem, it is no longer necessary to link the exemption
to the presence of a tax treaty. In the current environment,
it is more appropriate to link the exemption to the
presence of a comprehensive exchange of information
2007 therefore proposes to extend the exemption to active
business income from non-treaty jurisdictions as well
as treaty countries, provided those jurisdictions agree
to exchange tax information with Canada. This will give
Canadian firms more scope to expand internationally,
especially into new and emerging markets, without our
tax system imposing additional costs that could reduce
their competitiveness, while also maintaining tax fairness.
It will also encourage non-treaty jurisdictions to join
in the efforts of Canada and our treaty partners to
control international tax evasion."
December 2008, the Advisory Panel on Canada’s
System of International Taxation made the following
recommendations with regards the taxation of outbound
foreign direct investment from Canada:
Broaden the existing exemption system to cover all
foreign active business income earned by foreign affiliates.
Pursue tax information exchange agreements (TIEAs)
on a government-to-government basis without resort
to accrual taxation for foreign active business income
if a TIEA is not obtained.
Extend the exemption system to capital gains and losses
realized on the disposition of shares of a foreign
affiliate where the shares derive all or substantially
all of their value from active business assets.
Review the “foreign affiliate” definition,
taking into account the Panel’s other recommendations
on outbound taxation, the approaches of other countries,
and the impact of any changes on existing investments.
In light of the Panel’s recommendations on outbound
taxation, review and undertake consultation on how
to reduce overlap and complexity in the anti-deferral
regimes while ensuring all foreign passive income
is taxed in Canada on a current basis.
Review the scope of the base erosion and investment
business rules to ensure they are properly targeted
and do not impede bona fide business transactions
and the competitiveness of Canadian businesses.
Impose no additional rules to restrict the deductibility
of interest expense of Canadian companies where the
borrowed funds are used to invest in foreign affiliates
and section 18.2 of the Income Tax Act should be repealed.
response to the panel's report, Finance Minister Jim
Flaherty announced the following in the 2009 budget
Deductibility: Section 18.2 of the Income Tax Act,
scheduled to come into force in 2012, constrains the
deductibility of interest in certain situations where
a Canadian corporation uses borrowed funds to finance
a foreign affiliate and a second deduction for that
interest is available in the foreign jurisdiction.
Early action is being taken in relation to the Panel’s
recommendation concerning section 18.2 because of
the conclusions of the Panel on the potential effects
of the provision on foreign investment by Canadian
multinational firms, particularly in the context of
the current global financial environment. Accordingly,
it is proposed that section 18.2 be repealed.
Non-Resident Trusts and Foreign Investment Entities:
Outstanding proposals for non-resident trusts and
foreign investment entities, first introduced in the
1999 Budget, apply in respect of arrangements under
which Canadian residents seek to avoid Canadian tax
through the use of foreign intermediaries under circumstances
designed to circumvent the application of existing
anti-avoidance rules. The government has received
submissions, including the Panel’s recommendations,
on these proposals; the government supports the fundamental
policy objective of ensuring that Canadian taxpayers
should not be able to avoid paying their fair share
of income tax through the use of foreign intermediaries,
but will review the existing proposals in light of
these submissions before proceeding with measures
in this area.
Foreign Affiliate Proposals: The government will consider
the Panel’s recommendations relating to foreign
affiliates before proceeding with the remaining foreign
affiliate measures announced in February 2004, as
modified to take into account consultations and deliberations
since their release.
4 March 2010, Finance Minister Jim Flaherty presented
the 2010 budget in which it was stated that: "The
Government would, in response to submissions by the
Panel and others, review its outstanding proposals with
respect to tax issues associated with foreign investment
entities and non-resident trusts before proceeding with
measures in this area. As a result of this review, the
Government is initiating a consultation process for
revised proposals on which commentary is welcomed and
encouraged. The revised proposals would replace the
outstanding proposals relating to foreign investment
entities with several limited enhancements to the current
ITA and substantially modify the outstanding proposals
with respect to non-resident trusts in order to better
target and simplify them."