Outward Corporate Investment
Investment from Canada - The Offshore Perspective
By Caroline Maxwell, London
Canadian citizens, and those resident in the country for tax
purposes, there is really no way to permanently (and legally)
shelter foreign investment and business income from Canadian
income tax. International Business Companies (IBCs) seem to
offer a viable alternative, and may even prove effective in
sheltering assets from Canadian tax. However, the CCRA requires
that there must be some 'bona fide purpose' other than merely
tax avoidance for the establishment of an IBC, so their legality
for individuals in a Canadian context is usually questionable,
and you are sure to reap the whirlwind if caught out by the
CCRA. Immigrant and emigrant trusts, where properly structured,
provide partial and temporary protection for foreign assets,
and becoming non-resident in Canada is always an option, but
other than that, there are no real solutions for individuals.
There are, however,
effective and legal ways in which Canadian corporations can
utilise offshore affiliates in order to maximise the efficiency
of Canadian exempt surplus rules and minimise exposure to
FAPI legislation, and it is to these that we now turn. (For
the purposes of explanation, a non-resident corporation is
considered to be a foreign affiliate if the Canadian corporation
or related persons directly or indirectly own at least 10%
of any class of shares in that non-resident corporation.)
FAPI stands for
Foreign Accrual Property Income, and rules determining what
falls into this category (and is therefore liable for Canadian
income tax) have been significantly extended and strengthened
in recent years. FAPI now includes a foreign affiliate's income
for the year from property and business, with the exception
of income from 'active business'. On the other hand, Exempt
Surplus rules mean that dividends derived from active business
profits earned by an affiliate in a country with which Canada
has a double tax treaty are generally received tax free in
Canada. In order to establish a truly tax efficient corporate
structure, then, it is necessary to ensure that as much of
the Canadian corporation's foreign income as possible is derived
from active business (and therefore qualifies as exempt surplus
income, as opposed to Foreign Accrual Property Income).
stated, this is probably best achieved by the establishment
of a subsidiary corporation in an offshore jurisdiction, for
reasons which will be explained later. However, as the exempt
surplus rules specify, the affiliate must be in a jurisdiction
with which Canada has a double taxation treaty. Although overall,
Canada has over 86 (January 2007) such treaties, with several
more under negotiation, only a few of these are with offshore
jurisdictions. Of these jurisdictions, for the specific purpose
of establishing an active subsidiary, only Barbados and (to
a lesser extent now) Cyprus are really suitable in terms of
infrastructure, legislation and corporate taxation regimes.
New legislation which came into force in 2003 set out new
rules applying to Foreign Investment Entities (FIE), and applied
to holdings by Canadian residents in foreign entities (widely
defined) if the principal business of the non-resident entity
is an "investment business", which specifically
includes a business carried on by the non-resident entity
(alone or through a partnership) if the principal purpose
of the business is to earn rental income from real estate
or profits from real estate sales.
the rules are designed to accelerate a tax liability on income
from the FIE in the hands of Canadian taxpayers under one
of two income imputation methods each year, beginning in 2003,
which could be well in advance of when income is actually
received. There are complex exceptions from the new rules,
which advisers say are difficult to apply in practice, and
Canadian residents with possible FIE involvement are strongly
advised to take professional advice on their position.
A FIE can be any non-resident corporation or trust, or any
other entity that is formed and governed outside of Canada,
such as an association, fund, organization, joint venture,
or syndicate. Interests that could potentially be affected
by these new rules include, among others, investments in foreign
mutual funds, public and private corporations, call options
and certain convertible securities.
Exceptions from the FIE rules include foreign public company
shares or mutual fund units that are traded on a US, UK, or
certain other foreign stock exchanges or an interest in a
US real estate investment trust (REIT) or regulated investment
company (RIC). Foreign companies already caught by CFC (Controlled
Foreign Corporation) rules are also excluded. There is also
a limited exception for a 'widely held and actively traded'
holding in a country with which Canada has a double tax treaty,
but even then the holding must not have been acquired for
tax avoidance purposes.
The FIE rules apply to most Canadian taxpayers, including
individuals, corporations, trusts and partnerships. Individuals
who have been resident in Canada for less than five years
and certain non-profit entities are exempt.
his March 2007 budget, Finance Minister Jim Flaherty announced
that that he would eliminate the deductibility of interest
on debt taken on by companies to finance foreign affiliates
to stop companies claiming deductions both in Canada and the
country where they are making acquisitions.
the proposal provoked an outcry from businesses and tax experts,
who warned that the move could severely hamper Canadian firms'
ability to compete in both the international and domestic
a result of this outcry, Mr Flaherty was obliged to clarify
his proposal, insisting that the plan was aimed only at firms
exploiting offshore structures to 'double dip.'
one looks at what I've said, every time I've spoken on this
topic, I've said the focus and target is on double-dipping,
that is double interest deductions by corporations using tax
havens," Flaherty told reporters.
also added that: "We are going to make illegal the use
of double deductions and tax havens. They will have the benefit
of a single deduction."
about tax fairness. This is a continuing issue in Canada that
if we're going to lower taxes overall for individuals and
for corporations then we must have tax fairness - that is
everybody must pay their fair share and you don't pay your
fair share if you're using a tax haven and taking a double
In 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
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
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 in January:
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.
2004 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.
government is studying the other recommendations in the international
tax reform panel's report.
The strong historical
links between Barbados and Canada, coupled with the existence
of a double taxation treaty, and a favourable corporate taxation
regime for international companies mean that the island has
a specific appeal for Canadian corporations wishing to improve
their tax efficiency.
companies carrying out international trade, commerce, or manufacturing
business, and wishing to incorporate offshore, an International
Business Company (IBC) is usually the way to go (as long as
exports or services provided are to those outside the CARICOM
area). In order to qualify for an IBC license, the Canadian
company must establish a corporation in Barbados which fulfils
the following criteria:
- The subsidiary
company should be resident in Barbados, but;
- Not more
than 10% of the assets should accrue to residents of the
CARICOM area on liquidation, and;
- No more than
10% of dividends or interest income should be remitted to
residents of the CARICOM area.
are issued by the Minster of Finance and are renewable annually
for a fee of BDS$250. However, setting up an IBC in order
to achieve Canadian tax efficiency is far from cheap. In order
to satisfy the CCRA that the operation is not a sham, the
'central mind and management' must be located in Barbados,
and the IBC must be a full scale company, with working offices,
staff, international telecommunications facilities, bank accounts,
a board of directors, and a local attorney. Otherwise, for
the purposes of Canadian taxation, it will simply be 'looked
Once a Canadian
corporation has established an International Business Company
in Barbados to act as its offshore subsidiary, it can then
start to take advantage of the exempt surplus regime. Here
is an example of one way in which this could take place:
- Canacom, a
Canadian manufacturing company exporting products around
the world establishes an offshore subsidiary, Barbacom,
to handle its foreign sales and international marketing.
Barbacom charges a 15% mark-up on the value of the goods
it sells, or about $850,000 at current export levels. Because
corporate taxation for international corporations is only
2.5% in Barbados, as opposed to the Canadian rate of (45%
at the time of writing, but since reduced to a headline
rate of 19%), the local corporate income tax only comes
to a maximum of $21,250 (local expenses would in fact be
deducted from the $850,000). The remaining $828,750 (after
expenses) can be classified as income from an 'active business',
and is therefore not usually subject to FAPI rules, and
can be remitted back to the Canadian parent company as a
dividend from exempt surplus income under the Canadian foreign
will vary according to the nature and size of the business
being conducted by the Canadian parent company and its offshore
subsidiary, and expert advice is needed before even considering
a move of this kind, but as long as the offshore affiliate
is located in a jurisdiction which has a double taxation agreement
with Canada, and is conducting 'active business', tax savings
of this kind should be possible.
treaty was extensively revised in 2002. A
key article of the amended agreement is an improvement to
information exchange provisions. The Canadian Revenue Agency
is also seeking to crack down on a number of tax evasion schemes
designed to exploit loopholes in the original treaty, so another
important change was the inclusion of provisions for Canada
to tax capital gains when assets are clearly shifted from
one country to another solely for the purposes of capital
gains tax avoidance.
The corporate tax rules in Barbados are currently undergoing
some transformation as the country 'merges' its onshore and
offshore sectors to satisfy the demands of the OECD).
Cyprus was a very attractive jurisdiction for Canadian businesses
wishing to take advantage of low corporate taxation and Canada's
foreign affiliate taxation rules. However, commitments made
to the EU and the OECD have begun to nibble away at Cyprus's
corporate tax advantage. Cyprus was among the jurisdictions
which pledged to amend its tax regime in return for exclusion
from the OECD 'blacklist' in June of 2000, and although the
island promised that its company and trust management regime
would remain the same, Cyprus installed a new 'harmonised'
tax regime in 2003 under which a uniform corporation tax rate
of 10% applies to all types of company.
Prior to the
2003 changes, IBCs paid just 4.5% in corporate income tax,
compared with 20-25% for onshore companies.
Cyprus may therefore
remain a good jurisdiction in which to hold subsidiaries in
Eastern Europe and some other emerging markets (Cyprus has
good tax treaties with most such countries) and is of course
now part of the EU, but in general it may lose some of its
attraction compared to Barbados.
Until 2003, IBCs
in Cyprus were duly authorised offshore limited liability
companies, and the following conditions were imposed on foreign
corporations wishing to establish one as its offshore subsidiary:
- The entity
must be entirely foreign owned
- The objects
of the business and source of income must be outside Cyprus
- No local
borrowing is permitted
In addition to
these requirements, audited annual accounts must be filed
with the Central Bank, and all business enterprises are required
to register with the Registrar of Companies.
as from 1st January, 2003, an offshore company (IBC) no longer
has a separate taxation status, and is taxed according to
the same principles as a regular company. In addition, IBCs
are allowed to trade inside Cyprus. However, an existing IBC
which made an irrevocable commitment not to trade inside Cyprus
until 2006 could claim the existing low tax rate for the three
years 2003, 2004 and 2005.
jurisdictions favoured by Canadians (such as the Cayman Islands,
the Turks and Caicos Islands, the Netherlands Antilles, and
the Channel Islands) will continue to have their uses, but
Barbados and Cyprus will probably remain the two most frequently