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  It is common for businesses to consider international expansion as a means to achieve growth. Given the geographic proximity of Canada and the U.S., it is logical that many Canadian businesses would consider expanding into the U.S. and vice-versa. Below are discussed a few tax and compliance issues that must be considered when Canadian corporations expand into the U.S  

Repatriation of Funds

Withholding taxes

Foreign Affiliate Dumping (FAD) Rules

Loans to and from foreign affiliates

Thin capitalization rules

Back-to-Back Rules

Earnings Stripping Rules

Reporting obligations

  In part 1 of this series, numbers 1 to 3 were addressed.   Parts 4 and 5 were addressed in Part 2.  This final article in the series, part 3, looks at issues 6 to 8.     6.  Back-to-back rules Like the interest withholding rules, the Tax Act includes back-to-back rules that capture arrangements that may be intended to circumvent the application of the thin capitalization rules.  For example, a non-resident parent that intends to heavily capitalize a Canadian subsidiary with a large amount of debt may enter into an arrangement to have a non-resident bank make a loan to the Canadian subsidiary. Since the bank is an arm’s length party, and not a “specified non-resident shareholder” of the Canadian subsidiary, absent the back-to-back rules, the thin capitalization rules would not apply to such a loan. Very generally, where there is a nexus between the loan from the bank/intermediary to the Canadian subsidiary and the arrangement between the bank/intermediary and the non-resident parent, the back-to-back loan rules could apply to deem the loan from the bank/intermediary to have been made from the non-resident parent, and deem the interest payments made by the Canadian subsidiary to be made to the non-resident parent, for the purposes of the thin capitalization rules.[1] [1] Taylor Cao and Annika Wang, "Introduction to Inbound Investments in Canada," in 2021 YP Focus Virtual Conference (Toronto: Canadian Tax Foundation, 2021), 2: 1-59.       deductions that are denied by the earnings stripping rule are proposed to be able to be carried back 3 years or carried forward 20 years. The rule is proposed to not apply in certain circumstances, for example, to a “group” if the group’s aggregate net interest expense among Canadian members is below $250,000.   8.  Reporting obligations[3] If a Canadian-resident individual or a corporation is a direct shareholder of a corporation that is a foreign affiliate or a controlled foreign affiliate, the shareholder is obligated to file a T1134 information return in respect of the affiliate.  A Canadian-resident individual or corporation is also required to file a T1134 in respect of any other corporation that is a foreign affiliate or controlled foreign affiliate in which they have an indirect interest as a shareholder of another corporation, unless that indirect interest is held through a corporation resident in Canada. A partnership may also be required to file a T1134 in a fiscal period. This will be the case if a non-resident corporation is a foreign affiliate of the partnership in the fiscal period and if persons resident in Canada who are not exempt from Part I income tax are entitled to more than 10% of the income or loss of the partnership for that fiscal period.  Although the members of the partnership may also be deemed to own shares of the foreign affiliate owned by the partnership in proportion to the FMV of their interests in the partnership,   there should not be duplicate reporting obligations if the members of the partnership do not own shares of the foreign affiliate except through the partnership. T1134’s are due 10 months after the end of the year or period.     Although there is no legislative basis for the following, the CRA will administratively waive the obligation to file T1134s for “dormant” foreign affiliates of a taxpayer if the taxpayer’s total cost amount of all of their interests in foreign affiliates at any time in the year was less than CAD $100,000.  The CRA classifies a foreign affiliate as dormant in a year if it had gross receipts (effectively, any cash inflow including loans and proceeds from the sale of property) of less than CAD $25,000 and at no time in the year owned property with a total FMV of more than CAD $1,000,000. If the foreign corporation is not a foreign affiliate, then the shares or debts of that corporation are specified foreign property and must be disclosed in a T1135 information return if the Canadian shareholder’s total cost amount of specified foreign property exceeds CAD $100,000 at any time in the year.   Shares and debts of a foreign affiliate are not specified foreign property,   so interests in a foreign affiliate that are disclosed in a T1134 should not also be included in a T1135. Further, the cost amount of shares or debts of a foreign affiliate will be ignored in determining the total cost amount of the Canadian shareholder’s specified foreign property.   [3] Tim Barrett and Kevin Duxbury, "Corporate Integration: Outbound Structuring in the United States After Tax Reform," in Report of Proceedings of the Seventieth Tax Conference, 2018 Conference Report (Toronto: Canadian Tax Foundation, 2019), 18:1-76.   Nicholas Kilpatrick is a partner with the accounting firm of Burgess Kilpatrick and specializes in tax structuring and business development for his small and medium business sized clients.  Please visit our website at www.burgesskilpatrick.com.    

  It is common for businesses to consider international expansion as a means to achieve growth. Given the geographic proximity of Canada and the U.S., it is logical that many Canadian businesses would consider expanding into the U.S. and vice-versa. Below are discussed a few tax and compliance issues that must be considered when Canadian corporations expand into the U.S  

Repatriation of Funds

Withholding taxes

Foreign Affiliate Dumping (FAD) Rules

Loans to and from foreign affiliates

Thin capitalization rules

Back-to-Back Rules

Earnings Stripping Rules

Reporting obligations

  In part 1 of this series, numbers 1 to 3 were addressed.  This article will discuss Numbers 4 and 5 above.  Issues 6 to 8  will be discussed in Part 3 of this series.   4.  Loans to and from foreign affiliates Regardless of whether expansion into the U.S. or Canada is as a result of organic growth or an acquisition, a decision must be made as to how to fund the expansion - debt or equity. This section will provide an overview of the financing considerations when expanding into the U.S. and Canada. It may also be desirable to maximize cross-border debt financing from a repatriation perspective, as the Treaty generally reduces the interest withholding tax rate between Canada and the U.S. to 0%, whereas the dividend withholding tax rate is generally 5%. From a U.S. perspective, any distributions to the Canadian parent will be subject to withholding tax until all E&P has been exhausted.  In contrast, a Canadian subsidiary is able to return capital to its U.S. parent free of withholding tax; however, for U.S. tax purposes, the return of capital will still be treated as a dividend. Cross-border expansion often creates opportunities to implement tax-efficient financing structures that can drive additional benefits above and beyond plain vanilla intercompany debt financing. Two examples of common tax-efficient financing structures between Canada and the U.S. are shown below. Example 1 - Hybrid Instrument Financing Structure   In a Hybrid Instrument Financing Structure, a hybrid instrument, such as a preferred share, is used to achieve tax-efficiency. For example (see graphic 1 below), a Canadian parent ("CanCo") invests in preferred shares of its U.S. subsidiary ("USCo"). From a U.S. tax perspective, the preferred shares are viewed as debt, such that the preferred share dividend payments are considered interest, which is deductible against the income of the USCo. From a Canadian tax perspective, the legal form of the preferred shares is respected, such that preferred share dividend payments are considered dividends, which are deductible to CanCo under ITA subsection 113(1)  to the extent sufficient surplus and/or underlying foreign tax balances are available. As such, the end result is an interest deduction in USCo with no corresponding income inclusion in CanCo.                 Both of the examples above illustrate financing structures into the U.S. Similar structures using hybrid instruments and hybrid entities are available for investments into Canada as well. However, the benefit of the inbound Canadian structures is generally limited to a deferral opportunity, as opposed to the permanent savings that often result from the inbound U.S. structures. This is because of the additional layer of U.S. tax required as a result of the CFC rules discussed above. Please note that both hybrid instrument and hybrid entity structures are addressed in the Organization for Economic Co-operation and Development (OECD) Base Erosion and Profit Shifting (BEPS) project that is discussed in the "Emerging Issues" section below. Although not illustrated above for the sake of simplicity, tax-efficient financing structures often include Canadian unlimited liability corporations, which are disregarded for U.S. tax purposes, but regarded as corporations for Canadian tax purposes. From a compliance perspective, additional requirements not previously noted above that may be triggered by tax-efficient financing structures typically include the following: U.S. Compliance

• Form 8858 - Information Return of U.S. Persons With Respect to Foreign Disregarded Entities
• Form 8832 - Entity Classification Election
• Dual Consolidated Loss Election and Certification
• Form W-8BEN-E - Certificate of Status of Beneficial Owner for United States Withholding and Reporting (Entities)
• Form W-9 - Request for Taxpayer Identification Number and Certification
• FinCen114 - Report of Foreign Bank and Financial Accounts (FBAR)

  Canadian Compliance

• Form T1135 - Foreign Income Verification Statement[1]

  Loans to and from foreign affiliates[2]   Where the FA may have excess cash or the ability to secure financing at a more favourable rate than its Canadian parent it could lend such cash or the proceeds of the financing to its parent. Even if the loan was made in the commercial course of the business, there is no purpose test for the application of the upstream loan rules. The amount of the loan is included in OMB's income if outstanding for more than two years, with a full or partial deduction depending on OMB's surplus balances.  Accordingly, surplus computations need to be maintained to determine the extent of the deduction or if distributions may made to the extent of any surplus that is not being relied upon for such deduction. Where it is more advantageous to borrow outside Canada, the back-to-back loan rules may operate to deem the loan from the third party lender to be made directly to the Canco, where it has been made from the FA because it borrowed from the third party.[3]   a.  Taxation of Interest Income   For various reasons, including some reasons discussed below, loans to foreign affiliates will often be interest-bearing. If the lender corporation is a CCPC, the interest income earned by the CCPC should be aggregate investment income of the CCPC;  even though the foreign affiliate and the CCPC may be related or associated, the interest income should not be recharacterized as income from an active business unless the foreign affiliate is carrying on an active business in Canada. The absence of recharacterization creates a material disincentive to charge interest on loans to foreign affiliates when the foreign affiliate is carrying on an active business and is subject to tax in its country of residence at a rate that is less than the applicable CCPC investment income rate. For example, if the foreign affiliate is resident in the US and carries on an active business, its earnings will be subject to tax at the 21% US federal rate plus any applicable state taxes, while interest income paid to a CCPC could be taxed at a combined federal-provincial rate of up to 53.67%.  However, it may be nevertheless be advisable to charge interest on loans to foreign affiliates even with the rate differential in order to avoid, among other things, the potential recharacterization of the loans as equity for US tax purposes  or US dividend withholding taxes on returns of capital. For Canadian corporations that are not CCPCs, it generally makes sense to charge interest on loans to US-resident foreign affiliates. The effective federal-provincial corporate tax rate in Canada will likely be close the effective federal-state corporate tax rate in the US; thus, absent losses in the foreign affiliate or the application of US interest deduction limitations,   any inefficiencies created by the interest payment should be minor. Further, since interest payments from a US affiliate to a Canadian lender should generally not be subject to US withholding taxes,   the overall result of a cross-border interest payment may be more efficient than generating taxable income in the US and causing the affiliate to pay an exempt surplus dividend.   b.  Deemed Interest Income and Transfer Pricing   Corporations resident in Canada that make loans to non-resident persons or to whom amounts are owed by non-resident persons may be required to include a deemed interest benefit in their income if three conditions are met:

• The debt is owed by a non-resident person;
• The debt has been or remains outstanding for more than one year; and
• The amount included in the corporation’s income as interest on the debt is less than the interest that would have been included in income had interest been charged at a reasonable rate.

If these conditions are satisfied, the deemed interest benefit will be equal to the difference between interest at the prescribed rate (currently 1%)   for the portion of the year in which the debt is outstanding and the actual interest income inclusion in respect of the debt. A deemed interest inclusion can also arise in less straightforward instances, including back-to-back loans,   loans to or through partnerships,  and loans through trusts.  As a result, all lending arrangement involving a Canadian parent corporation and non-arm’s length entities must be reviewed to determine whether a deemed interest benefit can arise. An income inclusion will not arise if the debt is owed by a controlled foreign affiliate of the corporation and:

• Throughout the period that the debt was outstanding, it was used to:

o Earn income from an active business of the affiliate or to earn income that was deemed to be income from an active business of the affiliate; or o Make a loan to another controlled foreign affiliate of the corporation, if interest on the loan would not be included in FAPI (e.g. because the interest is deemed to be income from an active business of the lender affiliate); or

• The debt arose in the course of an active business carried on by the affiliate throughout the period that the debt was outstanding (e.g. an amount owed to the corporation as a result of inventory purchased by the affiliate, etc.).

[1] Justin Heisler and Darlene Shaw, "Cross-Border Tax Issues with a Business Focus," in 2017 Atlantic Provinces Tax Conference (Toronto: Canadian Tax Foundation, 2017), 3:1-25. [2] Taylor Cao and Annika Wang, "Introduction to Inbound Investments in Canada," in 2021 YP Focus Virtual Conference (Toronto: Canadian Tax Foundation, 2021), 2: 1-59. [3] Andrew Morreale and Andrew Somerville, "Structuring Outbound Foreign Expansion for Owner Managed Businesses," in 2017 Ontario Tax Conference (Toronto: Canadian Tax Foundation, 2017) 10:1-37.   For these purposes, a slightly different definition of controlled foreign affiliate is used.  This amended definition does not deem the corporation to own shares of the foreign affiliate that are owned by non-arm’s length non-residents or by non-residents who do not deal at arm’s length with a relevant Canadian shareholder. This more restrictive definition means that a foreign affiliate that is a controlled foreign affiliate for FAPI purposes may not be a controlled foreign affiliate for the purpose of avoiding an interest income inclusion on outbound loans. Again, an anti-avoidance rule may cause a foreign affiliate to not be a controlled foreign affiliate where options or similar rights exist or where shares have been acquired or disposed of to defer or avoid tax.   If the exception for loans to controlled foreign affiliates does not apply, then it is also possible that Canada’s transfer pricing rules could apply to adjust the interest rate charged on any loan by a Canadian-resident person to a non-arm’s length person.   Transfer pricing adjustments can arise where the terms of a transaction (e.g. the interest payable on a loan) do not reflect the terms that would have been selected by arm’s length persons.  If, for example, a Canadian-resident taxpayer made an interest free loan to a non-arm’s length foreign affiliate that is not a controlled foreign affiliate, the CRA could use a transfer pricing adjustment to include in the taxpayer’s income an amount equivalent to interest at an arm’s length rate. Determining whether a reasonable, arm’s length interest rate is being charged by the Canadian corporation is an art rather than a science and there will almost always be a range of potentially reasonable rates. Nevertheless, taxpayers must ensure that there is some rationale for the interest rate chosen and that the rationale is appropriately documented, as a failure to make reasonable efforts to select the interest rate or to maintain contemporaneous documentation can result in penalties in the event of a transfer pricing adjustment.  As a practical matter, resisting CRA attempts to make transfer pricing adjustments in the event of an audit will be far more difficult and expensive where the taxpayer lacks contemporaneous documentation. Taken together, interest-free loans to non-arm’s length non-resident persons by a corporation resident in Canada are likely to result in unanticipated adverse income tax consequences unless the borrower is a controlled foreign affiliate carrying on an active business. Even then, the timing of the borrowing and use of the borrowed money may result in a deemed interest income inclusion. As it will often not be possible to avoid an interest income inclusion and as there are often good US tax reasons to charge interest on loans to US affiliates (typically at the applicable federal rate (AFR)), charging arm’s length interest on outbound loans is a reasonable best practice. Upstream loans   If a foreign affiliate makes an interest-bearing loan to a Canadian corporation, the interest income will be included in the affiliate’s FAPI.   Nevertheless, where the affiliate is a US affiliate, charging interest on the loan is good practice to avoid the upstream loan being characterized as a distribution (potentially subject to US dividend withholding tax) or to prevent a US transfer pricing reassessment.   Foreign exchange gains and losses on loans from a foreign affiliate to a Canadian parent could result in capital gains and losses for the Canadian parent and FAPI for the foreign affiliate (with the use of a USD functional currency election by the Canadian parent again serving as a potential solution). More significantly, a loan from a foreign affiliate to its Canadian shareholder or a person not at arm’s length with the Canadian shareholder may result in the Canadian shareholder (and not the debtor, if the shareholder and debtor are not the same person) having to include the principal amount of the loan in computing its income.  This can include back-to-back loans, whereby the foreign affiliate makes a loan to an arm’s length person who thereafter makes a loan to the Canadian shareholder or a person not at arm’s length with the Canadian shareholder.  Further, income inclusions can arise where either the debtor or creditor is a partnership. In the owner-manager context, there are three principal exceptions that may apply to prevent the inclusion of an upstream loan in the income of the Canadian shareholder, or alternatively provide an offsetting deduction for the income inclusion:

• The loan is repaid within two years of the date that it arose (unless the repayment is part of a series of loans and repayments);
• The debt or loan arose in the ordinary course of the affiliate’s business and, at the time the debt or loan arose, there were bona fidearrangements to repay the debt within a reasonable time;  or
• The affiliate had enough exempt surplus, hybrid surplus, hybrid underlying tax, taxable surplus, underlying foreign tax and pre-acquisition surplus (as represented in the ACB of the shares of the affiliate) to allow for some or all of the upstream loan to have been paid to the Canadian shareholder as a tax-deductible dividend. This exception is only relevant to Canadian shareholders that are corporations).

  In contrast to the domestic shareholder loan rules,  the deadline for repayment of an upstream loan is tied to the date that the debt arose and not the end of the taxation year in which the debt arose. As in the domestic shareholder loan context, a series of loans and repayments should exist where a repayment is temporary but should not exist where repayment is made through a taxable transaction or where there is a mere succession of loans.   Whether or not bona fide arrangements exist for the repayment of a debt within a reasonable time should be a question of fact; the CRA’s administrative position is that the reasonableness of repayment obligations will be determined by reference to normal commercial practice for similar debts. Whether an affiliate has enough surplus in respect of a Canadian shareholder to shelter an income inclusion in respect of an upstream loan is determined on an annual basis because the relevant provisions are structured as an annual deduction and add-back.   If the affiliate’s surplus pools are reduced because of losses or dividends paid by the affiliate or are used by the Canadian shareholder to determine the taxability of other distributions, it is possible that the affiliate will have a net income inclusion in a following taxation year. If the upstream loan is denominated in Canadian dollars but the affiliate’s calculating currency is not the Canadian dollar, then foreign exchange fluctuations may also result in income inclusions in later taxation years. Should a Canadian shareholder be required to include an upstream loan in income, any subsequent repayment should entitle the shareholder to a deduction;   forgiving the debt will not be a repayment and will eliminate the Canadian shareholder’s ability to claim a deduction.  Repayments may also give rise to foreign exchange surprises: if the debt is not CAD-denominated, the CAD-denominated income inclusion should be determined using the relevant exchange rate at the time the debt arose, while the CAD-denominated deduction should be determined based on the proportion of the CAD-denominated debt included in income that has been repaid. Reorganizations of corporate groups with upstream loans can also lead to unexpected, adverse income tax consequences. For example, a sale of the shares of a foreign affiliate together with the assumption of an upstream loan by the share purchaser may not constitute a repayment of the loan by the former debtor. Non-specialists should either cause upstream loans to be repaid or should seek specialist advice prior to any reorganization.   5.  Thin capitalization rules   Both Canada and the U.S. have rules in place that limit interest deductions on debt owing to related non-residents, so as to prevent inbound companies from eroding the domestic tax base by stripping all of the taxable income out of the country in the form of interest deductions. From a Canadian perspective, the thin capitalization rules (discussed below)  may apply to limit the interest deduction available to a Canadian subsidiary of a non-resident to the extent that the debt-to-equity ratio of the Canadian subsidiary exceeds 1.5:1. Any interest expense that is considered to relate to debt in excess of the 1.5:1 debt-to-equity ratio is deemed to be a dividend paid by the Canadian subsidiary to the non-resident parent and such dividend is subject to Part XIII withholding tax, which would generally be 5% in the context of a Canadian subsidiary of a U.S. parent. As mentioned above, interest payments made by a Canadian subsidiary are generally deductible for the Canadian subsidiary, while dividend payments must be made out of after-tax income. Heavy reliance on debt capitalization from non-resident investors gives rise to concerns about the “erosion” of the Canadian tax base, because it creates interest deductions in the Canadian entity while interest income is earned by a non-resident, thus reducing the amount of Canadian taxes paid by the group as a whole. 22  Thus, countries are often motivated to limit the amount of debt capitalization by non-resident investors. The 1997 Report of the Technical Committee on Business Taxation (the Mintz Report), a comprehensive study of business taxation in Canada, stated the following regarding the policy rationale of limiting debt capitalization by non-residents: In the absence of legislative restrictions, foreign investors seeking to minimize taxes associated with an investment in Canada would tend to invest a disproportionate amount of debt (as opposed to equity) in Canada. The interest expense reduces income otherwise subject to tax in Canada. By thinly capitalizing a Canadian business enterprise, a foreign investor can receive a greater proportion of its return in the form of deductible interest payments […], rather than dividend payments out of after-tax income. The purpose of thin capitalization rules is to prevent this type of erosion of the domestic tax base in the country in which the business enterprise is being carried on. Canada has a number of rules that are aimed at restricting the amount of interest deductions a Canadian subsidiary can take as a result of debt capitalization, particularly in a related party context, including the thin capitalization rules, foreign affiliate dumping rules, and transfer pricing rules. The 2021 federal budget also proposed to introduce a new “earnings-stripping” rule. Canada’s thin capitalization rules are found in section 18 . Subsection 18(4)  generally denies a deduction for interest expense by a Canadian corporation (or trust) if the interest expense is paid or payable on “outstanding debts to “specified non-residents,” to the extent that the amount of the debt           Further, any amount of interest that is not deductible under the thin capitalization rules is also deemed to be a payment of a dividend for purposes of withholding tax. Therefore, in the above example, the $20 interest payment from CanCo to NRCo would be deemed, for withholding tax purposes, to be a $15 interest payment and a $5 dividend.   Nicholas Kilpatrick is a partner with the accounting firm of Burgess Kilpatrick and specializes in tax structuring and business development for his small and medium business sized clients.  Please visit our website at www.burgesskilpatrick.com.    

  It is common for businesses to consider international expansion as a means to achieve growth. Given the geographic proximity of Canada and the U.S., it is logical that many Canadian businesses would consider expanding into the U.S. and vice-versa. Below are discussed a few tax and compliance issues that must be considered when Canadian corporations expand into the U.S  

Repatriation of Funds

Withholding taxes

Foreign Affiliate Dumping (FAD) Rules

Loans to and from foreign affiliates

Thin capitalization rules

Back-to-Back Rules

Earnings Stripping Rules

Reporting obligations

  This article will discuss Numbers 1 to 3 above.  The remaining issues will be discussed in subsequent articles.  

Repatriation of Funds

Pursuant to subsection 90(1) of the Income Tax Act (ITA) , a Canadian-resident taxpayer is required to include in its income for a particular taxation year all dividends received from non-resident corporations. A Canadian-resident corporate taxpayer receiving a dividend on a share of an FA owned by the taxpayer may be entitled to a full or partial deduction in computing its taxable income under section 113. The amount of the deduction available under section 113 depends in part on the surplus account of the FA in respect of the taxpayer from which the dividend is prescribed to have been paid. There are four surplus accounts, and regulation 5901 provides that dividends are prescribed to be paid out of the surplus accounts in the following order:[1] 1) exempt surplus, which includes income and profits earned by an FA that is resident in a "designated treaty country" from an "active business" (as defined in subsection 95(1)) carried on by it in Canada or a designated treaty country; [1] Tim Barrett and Kevin Duxbury, "Corporate Integration: Outbound Structuring in the United States After Tax Reform," in Report of Proceedings of the Seventieth Tax Conference, 2018 Conference Report (Toronto: Canadian Tax Foundation, 2019), 18:1-76.   2) taxable surplus, which includes income and profits earned by an FA that is FAPI, or an FA's net earnings from carrying on an active business that is not included in exempt surplus; 3) hybrid surplus, which includes the taxable and exempt portion of capital gains realized by an FA from the disposition of a partnership interest or shares of another FA; and 4) pre-acquisition surplus, which is anything that is not deemed to be paid from one of the foregoing surplus accounts and effectively represents the taxpayer's investment in the FA. Paragraphs 113(1)(a) and (d) provide a full deduction for dividends prescribed to have been paid out of exempt surplus and pre-acquisition surplus, respectively. Paragraphs 113(1)(a.1), (b), and (c) provide a deduction in respect of applicable underlying foreign tax (UFT) paid by an FA  and any non-business-income tax paid by the recipient corporation in respect of dividends (for example, withholding tax) prescribed to have been paid out of hybrid surplus and taxable surplus. For dividends prescribed to have been paid from taxable surplus, the deduction under paragraph 113(1)(b) is limited to the UFT multiplied by the corporation's relevant tax factor (RTF) for the year, minus one. Taxpayers that receive taxable surplus dividends on a share of a corporation that was a CFA are also entitled to a subsection 91(5) deduction in computing their income for the year. This deduction equals the net amount added to the taxpayer's ACB of the share under subsection 92(1)   effectively, this is the portion of FAPI on the share of the CFA previously included in the taxpayer's income that was not deducted under subsection 91(4). Subsection 91(5) therefore aims to ensure that income or profits of an FA are taxed only once in Canada. For corporations, the subsection 91(5) deduction is available only to the extent that the amount of a dividend exceeds the portion deductible under paragraph 113(1)(b). For individuals, regulation 5900(3) deems all dividends to be paid out of taxable surplus for the purposes of subsection 91(5). Amounts deductible by a CCPC under section 113 are added to its GRIP. A positive GRIP balance allows a CCPC to pay or declare eligible dividends on its shares. Note that no portion of dividends paid by a non-resident corporation (including a CFA) is added to a shareholder's capital dividend account. This can lead to unfavourable tax results where an FA of a "private corporation" (as defined in subsection 89(1)) realizes a capital gain on a disposition of property, rather than the private corporation realizing a capital gain directly.   2.  Withholding taxes The Canadian domestic withholding tax rate on payments of passive-type income by a Canadian taxpayer to a non-resident person is 25% regardless of the characterization of the domestic payer or the non-resident recipient.   However, a reduced withholding tax rate may be available under a Canadian tax treaty depending on the characterization of the non-resident payee and, in some circumstances, the Canadian payer. Under the Canada-US Treaty, reduced treaty withholding tax rates are available only if the US payee is entitled to treaty benefits in respect of the payment received. Whether or not the US payee is entitled to treaty benefits requires a determination of (a) whether the US payee is resident in the US for purposes of the treaty; (b) whether the US payee is the “beneficial owner” of the payment; (c) whether the limitation on benefits provisions  apply to deny treaty benefits; and (d) the application of the rules in Articles IV(6) and IV(7) of the treaty dealing with fiscally transparent entities. The following expands on each of these four considerations for eligibility for reduced treaty withholding rates. Generally the US payee will be resident in the US for purposes of the Canada-US Treaty if it is a person (including a corporation) that, under the laws of the US, is liable to tax therein by reason of the person’s domicile, residence, citizenship, place of management, place of incorporation or any other criterion of similar nature.  Pursuant to the treaty residence tie-breaker rules, a corporation that is a resident of both Canada and the US under domestic laws (for example, a corporation that is domiciled in the US but has its central management and control in Canada) is deemed to be a resident of the country under the laws of which it was created.   Articles IV(6) and IV(7) of the Canada-US Treaty contain rules to either grant or deny treaty benefits where amounts are paid by or to a fiscally transparent entity.   Article IV(6) is a relieving provision designed to allow access to treaty benefits where a resident of a contracting state derives income through an entity that is fiscally transparent under that country’s laws and the country taxes the income as if the resident had derived the income directly. In the inbound context, this provision is relevant where a Canadian taxpayer (i.e., the Canadian corporate investee) pays an amount to a US partnership, a US LLC or another type of entity (or through a chain of entities) that is considered a fiscally transparent entity from a US tax perspective. Article IV(7) can apply to deny treaty benefits where one or both parties to the relevant payment is a fiscally transparent entity, regardless of how Article IV(6) may apply to the payment. Article IV(7) is intended to prevent the use of hybrid entities and the selective use of debt and equity to either duplicate interest deductions in Canada and the US or generate an interest deduction in one country that is not income in the other country.   3.  Foreign Affiliate Dumping Rules   Section 212.3, known as the Foreign Affiliate Dumping (FAD) rules is a broad provision described by the Department of Finance as "effectively extend[ing] an existing cross-border surplus stripping rule [section 212.1] to cover transactions involving foreign affiliates."  Referred to as the foreign affiliate dumping (FAD) rules, section 212.3 was designed to restrict a non-resident corporation ("parent") from using a corporation resident in Canada (CRIC) as an intermediary to invest in a foreign affiliate. The rules are intended to prevent the perceived erosion of the part I tax base (resulting from the exempt treatment of dividends from foreign affiliates in combination with the deductibility of debt incurred by the CRIC to invest in the foreign affiliate), as well as the part XIII tax base (resulting from the extraction of corporate surplus not subject to withholding tax). A CRIC caught by the FAD rules is deemed to have paid a dividend to the parent subject to part XIII withholding tax or to have reduced the paid-up capital (PUC) of one or more relevant classes of its shares. The 2019 budget proposed significant changes to the FAD rules. The discussion of these new rules concerns the legislative proposals released July 30, 2019.  However, these proposals are subject to a comment period that expired on October 7, 2019. At the time of writing, it is unclear whether Finance will introduce further changes to the proposals based on feedback. If enacted, the new FAD measures will apply to transactions or events occurring after March 18, 2019.     The Parent Trap   Whereas the FAD rules are currently limited to a CRIC controlled by a non-resident corporation, the proposals will extend the rules to a CRIC that is controlled by (1) a non-resident individual or (2) a group of non-resident persons not dealing with each other at arm's length. Thus, a "parent" under the FAD rules can refer to a corporation, a natural person, or a trust. A variety of previously innocuous circumstances may now be subject to these rules. A Canadian corporation that is owned by a non-resident individual is a CRIC for the purposes of the FAD rules. As a result, the FAD rules could apply to situations where an owner-manager who controls a CRIC with a foreign affiliate emigrates abroad and ceases to be a resident of Canada, or who dies and whose shares are acquired by an estate that is not a resident of Canada. The conditions under which the FAD rules, as proposed, could apply are not always so easily identified. For example, determining whether a group of non-resident persons deals with each other at arm's length would, absent a deemed non-arm's-length relationship,  be a factual determination to which a degree of uncertainty attaches. The key takeaway is that because a reference to a "parent" will no longer be limited to a corporation, the proposed amendments to the FAD rules, if passed, will apply to a much wider range of situations than was previously the case. "More Closely Connected Business" Exception Subsection 212.3(16)  of the current FAD rules sets out the "more closely connected business" (MCCB) exception. This provision generally operates to stop the FAD rules from applying when an investment by a CRIC in its foreign affiliate can be shown to "belong" more to the CRIC than to the parent, based on certain enumerated factors.   While there are no substantive amendments proposed for the MCCB exception, a discussion of the exception is relevant because it may no longer be possible to satisfy the exception in circumstances to which the FAD rules, as proposed, would apply. For example, one of the enumerated factors in the MCCB exception requires that (1) the officers of the CRIC had and exercised principal decision-making authority in respect of the investment in the foreign affiliate, and (2) a majority of those officers were resident and working principally in Canada at the time of the investment.  In the example of the emigrating owner-manager, it is unlikely that this factor could be satisfied if the owner-manager is the sole decision maker of the CRIC's business. Generally, the FAD rules allow a CRIC to suppress the PUC of its shares, rather than pay withholding tax on the deemed dividend that otherwise arises on the investment in the foreign affiliate.  This PUC offset mechanism is the usual means by which a taxpayer avoids withholding tax on the deemed dividend. However, this self-help remedy would seldom be a viable option for a private company, whose voting shares usually have low PUC. Accordingly, lack of access to the MCCB exception is particularly problematic for owner-managers.    

  In an increasingly globalized and digitized world, small and medium-sized enterprises can grow and compete internationally to an extent that was not previously possible. These same economic realities have also forced many small and medium-sized enterprises to expand outside of Canada or attract investment from outside of Canada in order to adapt and survive. Whether voluntary or involuntary, cross-border expansion and investment leads to international tax issues that may not be familiar to a private enterprise’s advisors.[1] When determining the optimal corporate structure to use when investing in the US, and the vehicle to contain that business in (ie: U.S C-corp, LLC, or LP), consideration must be given to the effective tax rate realized upon repatriation of that income to the Canadian individual taxpayer.  Such a calculation is necessary in order to determine in viability of the U.S investment.  Such a determination is facilitated via the calculation of the effective tax rate (ETR) realized by the Canadian taxpayer upon full repatriation of the U.S income. 3 Alternative corporate cross-border structures are analyzed below:

wholly owned Canadian corporation wholly owning a US LLC,

wholly owned Canadian corporation wholly owning a US corporation,

Canadian individual owning a US Corporation.

  The  alternative structures presented here are likely to be the most common that a Canadian investor would consider in developing a strategy for investing in, and exiting from, the United States. In all cases, the ultimate recipient of the income distributed through the structures analyzed is a Canadian individual who is a resident of Canada and not a resident or citizen of the United States.[2] In the alternatives that include a Canadian corporation, that entity is a CCPC for Canadian income tax purposes. The models generally consider only controlled US entities that qualify as CFAs for Canadian income tax purposes.   For each structure, we compute the ETR by assuming that structure derives US-source income that is from "income from an active business" for Canadian tax purposes. For US income tax purposes, the models reflect income that is US-source effectively connected income (ECI) and US-source capital gains, unless otherwise noted. They reflect both long-term and short-term [1] Byron S. Beswick and Michael Dolson, "International Tax for Owner-Managers," in 2020 Definitive Guide to Owner-Manager Taxation Virtual Conference, (Toronto: Canadian Tax Foundation, 2020), 10: 1-121. [2] Tim Barrett and Kevin Duxbury, "Corporate Integration: Outbound Structuring in the United States After Tax Reform," in Report of Proceedings of the Seventieth Tax Conference, 2018 Conference Report (Toronto: Canadian Tax Foundation, 2019), 18:1-76.     capital gain scenarios. Additionally, for the sake of simplicity, the capital gain scenarios assume that there is no recapture of tax deprecation. Canadian tax liability generally turns on whether a person is a resident or a non-resident of Canada. A person who is resident in Canada during a tax year is subject to Canadian income tax on his or her worldwide income from all sources, which includes income from an office, employment, property, or business. Accordingly, an individual who is a resident of Canada is subject to Canadian tax on any income earned directly from a source outside Canada. This includes dividends received on shares of non-resident corporations, which would generally be characterized as income from property and included in a taxpayer's income for the year in which the dividends are received (or in which the taxpayer becomes entitled to receive the amount). Subsection 91(1)  is an exception to the general rule that income is recognized in the year in which it is received or receivable by a taxpayer. Canadian taxpayers are subject to current taxation on FAPI earned by closely held corporations (CFAs)  regardless of whether the FAPI is repatriated to Canada in the year income or profits are realized by the CFA. Specifically, in computing taxable income for a taxation year, taxpayers are required to include their "participating percentage"  of the FAPI earned by each of their CFAs pursuant to subsection 91(1).  The amount corresponding to the taxpayer's FAPI inclusion for the year is added to the adjusted cost base (ACB) of its shares in the CFA. Under new rules applicable to taxation years beginning after 2018, a CCPC will be entitled to a dividend refund for refundable tax paid on FAPI included in a CCPC's income only when the CCPC pays out non-eligible dividends.  These new rules can adversely affect ETRs on US outbound structures in certain limited circumstances.   Limited Liability Companies and Anti-Hybrid Rules   This discussion summarizes the availability of Canadian deductions and credits for US tax paid in respect of income earned by an LLC that is fiscally transparent for US tax purposes. We also touch briefly on the application of the Canada-US treaty to LLCs where it affects the integration tables. For the purposes of this discussion, it is assumed that the LLC interest is held directly by a Canadian-resident individual ("individual member") or a corporation resident in Canada ("corporate member"). Structures 3, 5, 7, and 8 in the integration tables in the appendixes summarize the integrated rates for investing through different LLC structures.   Nature of an LLC   Unless an LLC elects to be treated as a corporation, a single-member LLC is disregarded as an entity separate from its member, and a multiple-member LLC is treated as a partnership for US federal income tax purposes. Since the United States does not impose tax on fiscally transparent LLCs, Canadian residents that invest directly in LLCs (or indirectly through other transparent entities) are subject to US tax on their income attributable to or allocable from the LLC. ECI earned by a non-resident individual or a foreign corporation through a disregarded LLC is generally subject to estimated tax payments and reporting requirements similar to those that apply to US individuals and corporations, respectively. If an LLC that is treated as a partnership has ECI, and if any   portion of that ECI is allocable to a foreign partner, the LLC must withhold tax at the highest rate applicable to individuals (37 percent) or corporations (21 percent), as applicable. The LLC must remit the withholding tax regardless of the relevant foreign partner's ultimate US tax liability, and regardless of whether the partnership makes a distribution. The relevant foreign partner must file a US tax return in respect of its allocable ECI. By contrast, Canada views LLCs as corporations for tax purposes. For the purposes of the Act, LLCs are treated as having share capital, and therefore can qualify as an FA or a CFA of a taxpayer, with the attendant tax consequences including computing and tracking surplus pools and recognizing FAPI under subsection 91(1).  Distributions of income or profit from an LLC are treated as dividends for Canadian tax purposes.   US Taxes Paid on Income of a Foreign Affiliate LLC   US tax paid by Canadian residents in respect of income allocated from an LLC is considered non-business-income tax for Canadian tax purposes.  Although for US tax purposes members of an LLC are considered to carry on the business of the LLC, this treatment is not recognized for Canadian tax purposes. Accordingly, taxpayers are considered to have paid US tax in relation to, or in respect of, the holding of the LLC interest and not the LLC's activities. This treatment determines the availability of credits and deductions under Canadian tax law for US tax paid by a Canadian-resident member. C corp Although more complicated to operate, a C Corporation provides the most personal liability protection for shareholders in a company. The IRS considers a C Corporation an independent taxpayer and associates its income and expenses with the business, not its owners (shareholders). Ownership of a C Corporation is established through issuing shares of stock, either held privately or publicly. A C Corporation (unless it files for the S Corporation election) must pay federal income tax on company profits at the corporate tax rate. In some circumstances, the corporate tax rate may be lower than paying the individual tax rate on business profits (as with an LLC). As a C Corp, your company may be eligible for tax deductions not available to other business structures. Unlike with a sole proprietorship (and in the case of some LLCs), a C Corporation will survive beyond its owners’ life spans.                 As can be seen from the ETR analysis, combined US-Canadian tax rates can differ depending on corporate structures selected.  The optimal combined Canadian-US corporate structure will ultimately depend on the preferences of the Canadian taxpayer as they relate to tax minimization, liability protection, and estate planning preferences.   Nicholas Kilpatrick is a partner with the accounting firm of Burgess Kilpatrick and specializes in tax structuring and business development for his small and medium business sized clients.  Please visit our website at www.burgesskilpatrick.com.  

  International competitiveness is a rather ill-defined term since it could have a variety of meanings. It might mean how competitive a country might be as a place of location for investments and production compared to other jurisdictions. It could also imply how competitive a home-based multinational resident is relative to other multinationals operating at a worldwide scale. These concepts are not the same. An important element in attempting to maintain Canada as a desirable country to attract foreign investment from is the efficiency of it’s tax structure.  Efficiency implies that the tax system should distort economic decisions as minimally as possible so that individuals and businesses make choices based on economic gains that are not influenced by tax considerations. To this end the Department of Finance strives to maintain a foreign affiliate tax regime that facilitates tax-efficiency.  If a Canadian resident earns income abroad, Canada has a tax credit and deduction system that, in theory, offsets the foreign tax paid so that the ending tax obligation of that resident is consistent with Canadian personal tax rates.  Perfect integration of course is not always realized, but the intention remains. The foreign affiliate regime is designed to ensure Canadian companies are not at a disadvantage when expanding their active business abroad through foreign subsidiaries by permitting, in general terms, earnings of an active business of a "foreign affiliate" ("FA") to not suffer Canadian tax when earned, or when distributed as a dividend to its Canadian corporate (not individual) shareholder provided certain conditions are met. Further, it permits planning to reduce foreign tax applicable to active income by shifting income from one FA to an FA in a lower-tax jurisdiction.   Nature of Income to be Earned in the Foreign Jurisdiction The nature of income from foreign activities, and the form in which it is earned, dictates its taxation. In general, income from property is not taxed as favourably as income from an active business, whether earned directly through a branch or partnership or indirectly through a CFA of a CCPC. Where foreign income is earned directly, the main question is whether the income constitutes income from an active business[1]  ("ABI"), which excludes Aggregate Investment Income (“AII”). AII is defined to be, in part, income from a source that is property, which includes income from a "specified investment business"  ("SIB") carried on in Canada. AII is subject to refundable surtax, increasing the tax payable until distribution to individual shareholders. Where foreign income is earned through a CFA, again, the question is whether it constitutes income from an active business ("FA ABI"), but such income is defined differently. The FA ABI definition excludes income from an "investment business", which is similar but not identical to a SIB. Although similar in concept, AII under the CCPC rules differs from FAPI under the CFA regime; in short, the latter is broader than the former. For instance, the definition of SIB is narrower than [1] Structuring Outbound Foreign Expansion for Owner Managed Businesses, Canadian Tax Foundation, Andrew Morreale, Andrew Somerville.     "investment business" under the CFA regime. Although both are defined to include, in part, a business the principal purpose of which is to earn income from property (unless the prescribed number of employees are actively engaged in the business), the domestic definition is restricted to such income from property, whereas the FAPI related definition is broader in two respects. First, in the case of the "investment business" definition, the principal purpose of the business is not limited to earning business income in the form of income from property, but rather its principal purpose can be to earn income from other sources, including profits from the disposition of an "investment property" (which includes real property). Second, the SIB definition excludes income from a source outside Canada that is property. Business income earned by a CCPC that takes the form of income from property from carrying on business activities through a foreign branch (directly or through a partnership) should be treated as ABI under the CCPC rules (even if its income is from a source outside Canada that is property); but if business income in the form of income from property is earned by a CFA, it should constitute FAPI, which in turn should be included in AII (on the basis that such activity should be considered to be an investment business unless it has the requisite number of employees or equivalent employees). Therefore, it is possible to be in a situation whereby the income earned by an FA is FAPI where, if earned by a CCPC in the domestic context it would be considered to be income from an active business.   Residency A very common issue with respect to OMBs that expand abroad is maintaining the residency of the FAs in the country in which the FA is carrying on its activities. Residency must be considered under 1) the common law test for Canadian purposes, 2) the domestic law of the foreign jurisdiction, and 3) a relevant tax treaty, if any. Under the common law test, a foreign incorporated company will be considered to be a tax resident of Canada where its central management and control is exercised in Canada.62  In very general terms, central management and control is considered to reside where strategic decisions are made, as distinct from day-to-day management decisions. The strategic decisions of a corporation are typically made by the board of directors and, therefore, central management and control of a corporation is generally considered to be where the directors reside and meet to make strategic decisions in respect of the business. It is often best practice for a majority of the board of directors to be residents of the country in which the FA conducts its business so that it is considered a resident there under the common law test. Common Indicia of Residency There is no bright-line test for establishing where central management and control of a corporation is exercised. All relevant facts and circumstances have to be considered over the entire time period of the corporation's existence such as: 1) Where do the majority of the directors reside? While not determinative, it will likely be factually easier to evidence central management and control in being exercised the country the directors live. Should the board have Canadian resident directors, they should   physically attend board meetings in the foreign country, and not remotely via phone or video conference. 2) Is there documentation to support board meetings? Board meetings should be documented, and during such meetings, the board of directors, should exercise its control and make decisions relating to the company's operations and general policies such as investment, financing and dividend payments. Being able to form a functioning board in the country where the FA carries on business can be very challenging for OMBs, especially those that may be in the early stages of expanding and do not have the financial resources nor the need to engage foreign directors. Further, most entrepreneurs and business owners are very heavily involved in the strategic management of their businesses and consider the decision to expand abroad to be significant and are often hesitant to give up any control of their foreign operations (to either employees in the local jurisdiction or independent directors who reside there). As a result, consideration must be given to whether or not residency of the FA can be properly maintained outside of Canada, as this will impact the appropriate structure. For example, if there is concern that the US subsidiary will be considered to be a resident of Canada under the common law test (because the sole director is the Canadian resident owner-manager who makes most of the strategic decisions in respect of the US corporation while in Canada), consideration should be given to forming a US C-corporation (or regarded LLC) so that the corporate tie-breaker rule in the Treaty can be invoked. The Treaty tie-breaker rule provides that where a company is considered a resident of Canada and also a resident of the US, it is treated as resident only of the US based upon its place of incorporation. It is important to note that not all of Canada's tax treaties contain a place of incorporation "treaty-tie breaker rule." One such example is Canada's tax treaty with the UK, where the CRA could take the position that a UK subsidiary that is incorporated under the laws of the UK and operates solely in the UK is a resident of Canada because its central management and control is exercised in Canada. Absent Competent Authority resolution concluding on UK residency only , the UK subsidiary could be subject to Canadian income tax on its worldwide income together with the requisite Canadian income tax filing and reporting obligations. Disregarded US LLC: Impact of the Canadian Residency Rules As outlined above, subject to the application of an applicable tax treaty with a corporate residency tie-breaker rule, a foreign incorporated company will be considered to be a tax resident of Canada under the common law test where its central management and control is exercised in Canada. However, this is not always the case, particularly in the context of disregarded LLCs as they are not eligible to claim the benefits of the Treaty, so the corporate tie-breaker rule does not apply. Conversely should the central management and control of an LLC be exercised in the US, the issues below should not apply and the Canadian FA rules will continue to govern the Canadian tax treatment. A disregarded LLC is unable to access treaty benefits in respect of its residency because treaty residency requires the entity to be fully liable to tax and, for US tax purposes, LLCs are fiscally transparent with their members being taxable on LLCs profits for US tax purposes. Accordingly, both Canada and the US have taxing rights over the income of an LLC where it is a resident of Canada under common law principles, thus giving rise to the potential for double taxation to apply. To avoid the potential for double taxation where a disregarded LLC is owned by a Canadian taxpayer, care should be taken to ensure that if there are Canadian resident individuals in a position to exercise central management and control of      

  International competitiveness is a rather ill-defined term since it could have a variety of meanings. It might mean how competitive a country might be as a place of location for investments and production compared to other jurisdictions. It could also imply how competitive a home-based multinational resident is relative to other multinationals operating at a worldwide scale. These concepts are not the same. An important element in attempting to maintain Canada as a desirable country to attract foreign investment from is the efficiency of it’s tax structure.  Efficiency implies that the tax system should distort economic decisions as minimally as possible so that individuals and businesses make choices based on economic gains that are not influenced by tax considerations. To this end the Department of Finance strives to maintain a foreign affiliate tax regime that facilitates tax-efficiency.  If a Canadian resident earns income abroad, Canada has a tax credit and deduction system that, in theory, offsets the foreign tax paid so that the ending tax obligation of that resident is consistent with Canadian tax rates.  Perfect integration of course is not always realized, but the intention remains. The foreign affiliate regime is designed to ensure Canadian companies are not at a disadvantage when expanding their active business abroad through foreign subsidiaries by permitting, in general terms, earnings of an active business of a "foreign affiliate" ("FA") to not suffer Canadian tax when earned, or when distributed as a dividend to its Canadian corporate (not individual) shareholder provided certain conditions are met. Further, it permits planning to reduce foreign tax applicable to active income by shifting income from one FA to an FA in a lower-tax jurisdiction.   Canadians Considering Outbound Investment to a foreign business Canadian tax liability generally turns on whether a person is a resident or a non-resident of Canada. A person who is resident in Canada during a tax year is subject to Canadian income tax on his or her worldwide income from all sources, which includes income from an office, employment, property, or business.  Accordingly, an individual who is a resident of Canada is subject to Canadian tax on any income earned directly from a source outside Canada. This includes dividends received on shares of non-resident corporations, which would generally be characterized as income from property and included in a taxpayer's income for the year in which the dividends are received (or in which the taxpayer becomes entitled to receive the amount). There is one exception to the general rule that income is recognized in the year in which it is received or receivable by a taxpayer. Canadian taxpayers are subject to current taxation on FAPI (Foreign Accrued Property Income)  earned by Controlled Foreign Affiliates (CFAs)  regardless of whether the FAPI is repatriated to Canada in the year income or profits are realized by the CFA. Specifically, in computing taxable income for a taxation year, taxpayers are required to include their "participating percentage" (ie: the percentage of the FAPI that they have entitlement to through their ownership) of the FAPI earned by each of their CFAs pursuant to subsection 91(1) of the Income TaxAct (ITA). The amount corresponding to the taxpayer's FAPI inclusion for the year less the deduction available under ss. 91(4) on that FAPI income is added to the adjusted cost base (ACB) of its shares in the CFA.     2) It is almost always most tax efficient, to the extent commercially possible, to leverage a foreign subsidiary's operations with interest bearing debt, and seek to maximize the interest charged, as supported using transfer pricing principles. 3) Failure to maintain residency of an FA outside of Canada may result in adverse tax consequences. 4) Non-interest bearing debt may result in imputed income to a Canadian lender or shareholder. 5) It is generally preferable to have the shares of an FA held in a separate corporate group from the Canadian operating companies if access to the lifetime capital gains exemption is contemplated. 6) Care must be taken to ensure, to the extent possible, integration is maintained, which often requires modelling to consider the combined ETRs of the foreign tax, Canadian corporate tax and if applicable individual personal tax once the profits are distributed to the individual shareholders.   Type of Entity The use of LLCs is common but, as discussed further below, LLCs may lead to undesirable tax results if transparent for US tax purposes (with member(s) of the LLCs being taxable in the US on the LLC's income). When using an LLC, it is essential that central management and control reside outside Canada; otherwise, the LLC is taxable in Canada similar to a Canadian formed company. In contrast, similar residency issues do not arise with US C-corporations ("USCo"), which are opaque for both Canadian and US tax purposes. An USCo, as opposed to its shareholder(s), is taxable on its income. Although often preferred to access exempt surplus treatment for distributions, central management and control is not as crucial where the USCo is eligible to claim the benefits under the Canada-United States Tax Convention (the "Treaty") and sufficient US tax is paid by USCo. The Treaty has a rule that deems a US incorporated company with central management and control exercised in Canada to be a resident of the US. Non-corporate business forms include branches and partnerships. Limited partnerships ("LP") are generally favoured as they offer liability protection for partners. LPs are fiscally transparent for both Canadian and US tax purposes, with LP partners being subject to both US and Canadian tax on their respective shares of LP income. More specifically, a Canadian partner of an LP that carries on business in the US through a permanent establishment ("PE") is required to file a US tax return to report its share of LP income (as computed under US tax rules) and liable to US tax on such income. Similarly, the Canadian resident partner is also taxable on its share of LP income (as computed under Canadian tax rules and in Canadian dollars) with relief for US tax paid.  The computation of income under US rules will differ from the Canadian computation primarily because of depreciation rates, timing of income recognition, deductibility of various expenditures, etc. It is important to note that while LPs are considered fiscally transparent for both Canadian and US tax purposes, the CRA has recently taken the position that certain other US partnerships (limited liability partnerships and limited liability limited partnerships formed under Florida or Delaware law) should be treated as corporations for Canadian tax purposes.  This new position results in a different tax treatment    

      Leading Tax Advice Call Nicholas Kilpatrick 604-612-8620   When a Canadian corporation (Canco) considers expansion into the U.S, careful consideration of key factors is necessary  from a Canadian and U.S. federal and state tax perspective so that Canco expands to the U.S. in the right way. An important goal is to structure the expansion so as to minimize the overall tax costs, achieve tax deferral to the extent possible and manage tax compliance obligations. In addition, it will be important to ensure that Canco recognizes the complexities resulting from carrying on business in two jurisdictions.[1] Key Factors When Considering U.S Expansion  

Residency

US sourced-based income

US Trade or Business

Effectively Connected Income (ECI)

Permanent Establishments

Distributions

US State Tax Obligations

  Part 2 of this article will discuss issues 3 to 7 above.     3.  US Trade or Business   The next question after considering the source of the income is to consider whether the sales are part of a US trade or business. There is no comprehensive definition of a US trade or business in the Code. However, the Code does state that a US trade or business includes the performance of personal services within the United States at any time within the taxable year.  The Code excludes the performance of personal services for foreign corporations not engaged in a US trade or business by a non-resident individual temporarily present in the United States for a period not exceeding ninety days and receiving compensation not exceeding $3,000. The Code also excludes trading in securities or commodities through a resident broker, commission agent, custodian, or other independent agent. Apart from these brief rules, whether a foreign corporation is engaged in a US trade or business depends on the applicable facts and circumstances. As such, the determination of whether a foreign corporation is engaged in a US trade or [1] Expanding to the U.S The Right Way – Know Before You Go, Canadian Tax Foundation, Catherine A. Brayley, Sidhartha Rao.     business has been left to the courts. This determination is generally based on the nature and extent of the foreign corporation's economic activities in the United States. 4.  Effectively Connected Income (ECI)   Along with a US trade or business, the second thing needed to be taxable in the United States on business income is income that is effectively connected with the conduct of that US trade or business. The United States calculates income tax on a foreign corporation's net taxable income that is effectively connected with the conduct of a trade or business in the United States. Deductions from ECI   Ordinary corporation income tax is imposed on a foreign corporation's taxable income, net of applicable deductions, that is effectively connected with the conduct of a US trade of business. The Code permits non-US corporations to take deductions only to extent they are related to or connected with gross income that is ECI.  To determine what portion of the deductions relate to US ECI, Treasury Regulations prescribe that taxpayers should categorize gross income into "buckets" (e.g., service fees, income from a business, income from selling property, interest, rents, etc.) and that deductions be apportioned to these buckets according to their relationship with each item of gross income. Interest deductions are subject to a special regime that seeks to apportion deductions to categories of gross income. 5.  Permanent Establishments   The Canada-US Tax Treaty overrides certain areas of US and Canadian domestic tax law to reduce instances of double taxation. Generally, the Treaty limits the ability of the United States to tax a Canadian corporation's business profits to those business profits that are attributable to a US permanent establishment (PE). The Treaty provides that a PE is a fixed place of business through which the business of the foreign corporation is wholly or partially carried on. A PE includes a place of management, branch, office, factory, workshop and mine, oil or gas well, quarry or any other place of extraction of natural resources. The Treaty specifically excludes from the definition of a PE the maintenance of a stock of goods or merchandise belonging to the foreign corporation for the purpose of storage, display or delivery. In order to be eligible for Treaty benefits under the Canada-US Tax Treaty, a person must be a resident of Canada or the United States under Article IV. As analyzed above, under that article, a corporation is generally resident in the country where it is formed. Even if a person is a resident of Canada or the United States, that person must also meet the tests set out in the Treaty's limitation of benefits provision (LOB). The LOB extends treaty benefits only to "qualifying persons" of Canada or the United States.  A corporation can be considered a qualifying resident if its principal class of shares is primarily and regularly traded on one or more recognized stock exchanges. A corporation can also be a qualifying person if it meets an ownership test and a "base erosion" test. A corporation resident in Canada or the United States will satisfy the ownership test if 50 percent or more of the vote and value of its shares is not owned, directly or indirectly, by persons other than qualifying persons. The "base erosion" test requires that less than 50 percent of expenses that are paid or payable by the corporation to persons that are not qualifying persons, and that are deductible from gross       Act Now To Get Our Value Pricing Adjustment on Audit and Review Engagements For Your Business   income, be less than 50 percent of the gross income of the corporation. For these purposes, a qualifying person is a resident of Canada or the United States.   A Canadian parent corporation may operate its US retail store as a US branch or through a US subsidiary. Under US income tax law and under the Treaty, there should be no particular tax advantage to operating in branch form compared to operating through a subsidiary. The branch profits tax (BPT) is supposed to act like a dividend withholding tax for US branches, with the intention of equalizing the US withholding tax burden of foreign corporations operating in the United States through a branch and through a subsidiary. BPT applies to a US branch's earnings and profits (E&P) repatriated to the Canadian corporation and not reinvested in the US trade or business. E&P is, in a way, like a tax version of retained earnings. The amount of repatriated E&P is determined by formula. Generally BPT applies at 30 percent of repatriated E&P unless it is reduced by treaty. The Canada-US Tax Treaty can reduce BPT to 5 percent. If a Canadian parent corporation (Canco) decides to operate the retail store through a US subsidiary, Canco can expect to pay a withholding tax on amounts distributed from the US subsidiary back to Whitestorm Canada. For US federal income tax purposes, a dividend is a distribution of cash or property by a corporation to its shareholders with respect to its stock, from its accumulated or current E&P. Distributions made out of a corporation's current or accumulated E&P are treated as taxable dividends, and should be subject to 30 percent US withholding tax. The Treaty reduces withholding tax on dividend payments to 15 percent in general and 5 percent if the corporation receiving the dividend owns at least 10 percent of the voting stock of the paying corporation. Distributions made in excess of E&P are treated first as a return of capital to the extent of a shareholder's basis in the stock, then as a capital gain for all distributions in excess of E&P and all available basis.   6.  Distributions For Canadian income tax purposes, the character of distributions from a foreign affiliate to the Canadian corporate shareholder depend on the activities of the foreign affiliate. A US corporate subsidiary is a foreign affiliate of a Canadian corporation if the Canadian corporation directly owns at least 1 percent in the US corporation and the Canadian corporation and its related persons together own at least 10 percent in the US corporation. A controlled foreign affiliate is generally a foreign affiliate that is controlled by the Canadian corporation or some combination of the Canadian corporation and other non-arm's length persons.  A Canadian corporation's ownership is determined by taking into consideration its direct and indirect ownership in the US corporation. The income a foreign affiliate earns can fall into one of several categories. For the purposes of this discussion, the most relevant categories are income from an active business and foreign accrual property income (FAPI).  These 2 income types are dealt with in another article and will not be analyzed here. 7.  US State Tax Obligations   The thresholds which make a foreign corporation taxable in any state differ from the federal thresholds and also differ between states. Many states also take the position they are not a party to federal tax       treaties, including the Canada-US Tax Treaty. Generally, states require a minimum connection or "nexus" between the activities of a taxpayer and the taxing state. Each state imposes its own nexus thresholds. It is common for Canadian companies to conclude that since they do not have permanent establishments in the U.S. and are therefore not subject to U.S. federal income tax, their only tax obligations are in Canada. Unfortunately, these conclusions would be very premature. The various states in the U.S. are not signatories to the Treaty. Accordingly, states are not bound to concepts of “permanent establishments” that may otherwise limit their ability to impose an income tax on an out-of-state taxpayer.  States are restricted, by the U.S. Constitution and legislation passed by the U.S. Congress, from imposing an income tax on an out-of-state taxpayer that lacks “substantial nexus” with a specific state. Substantial nexus is the minimum contact with a state that allows the state to impose an income tax on an out-of-state taxpayer. The activity or presence that triggers substantial nexus has changed over time and in general has shifted towards the ability for states to impose a tax burden. This rationale by U.S states has opened the door to what is now referred to as “economic nexus” for state income tax purposes. Economic nexus is the notion that deriving income from sources within a state is enough to create substantial nexus. Substantial nexus in the context of state income tax was at one time believed to also require physical presence in a state. Physical presence would include leasing or owning property within the state or having employees or agents enter the state. However, In Quill Corp. v. North Dakota(Quill), the U.S. Supreme Court ultimately ruled that physical presence was not required to adhere to Due Process requirements in the context of requiring an out-of-state taxpayer to collect state use tax. After Quill, states began adopting legislation that would require out-of-state taxpayers to file income tax returns in a particular state if they derived income from sources within the state even if they lacked physical presence.   Since Quill only dealt with state sales and use taxes and the physical presence needed for Commerce Clause purposes, states took advantage of this ambiguity in the decision and implemented economic nexus doctrine to supplant physical presence requirements for purposes of state income taxation. Today, almost all states with an income tax have adopted some form of economic nexus for purposes of establishing substantial nexus. Many of the larger states like California and New York have adopted bright-line nexus amounts which establish thresholds for sales, property and payroll in the state that will trigger nexus. There are many considerations relevant in the process of considering whether or not to expand to the U.S, and if so, how to structure that expansion.  The above discussion is not exhaustive, and care should be taken to ensure that the expansion is done in such a way as to facilitate the tax, operational compliance needs of the Canadian parent corporation. Nicholas Kilpatrick is a partner with the accounting firm of Burgess Kilpatrick and specializes in tax structuring and business development for his small and medium business sized clients.  Please visit our website at www.burgesskilpatrick.com.    

      Leading Tax Advice Call Nicholas Kilpatrick 604-612-8620   When a Canadian corporation (Canco) considers expansion into the U.S, careful consideration of key factors is necessary  from a Canadian and U.S. federal and state tax perspective so that Canco expands to the U.S. in the right way. An important goal is to structure the expansion so as to minimize the overall tax costs, achieve tax deferral to the extent possible and manage tax compliance obligations. In addition, it will be important to ensure that Canco recognizes the complexities resulting from carrying on business in two jurisdictions.[1] Key Factors When Considering U.S Expansion  

Residency

US sourced-based income

US Trade or Business

Effectively Connected Income (ECI)

Permanent Establishments

Distributions

US State Tax Obligations

  This article will discuss issues 1 and 2 above, while part 2 will discuss issues 3 to 7.  

Residency

A very common issue with respect to Owner Managed Business's (OMB's) that expand abroad is maintaining the residency of the FAs in the country in which the foreign affiliate (FA) is carrying on its activities. Residency must be considered under 1) the common law test for Canadian purposes, 2) the domestic law of the foreign jurisdiction, and 3) a relevant tax treaty, if any.[2] Under the common law test, a foreign incorporated company will be considered to be a tax resident of Canada where its central management and control is exercised in Canada. In very general terms, central management and control is considered to reside where strategic decisions are made, as distinct from day-to-day management decisions. The strategic decisions of a corporation are typically made by the board of directors and, therefore, central management and control of a corporation is generally considered to be where the directors reside and meet to make strategic decisions in respect of the business. [1] Expanding to the U.S The Right Way – Know Before You Go, Canadian Tax Foundation, Catherine A. Brayley, Sidhartha Rao.   [2] Andrew Morreale and Andrew Somerville, "Structuring Outbound Foreign Expansion for Owner Managed Businesses," in 2017 Ontario Tax Conference (Toronto: Canadian Tax Foundation, 2017) 10:1-37.   It is often best practice for a majority of the board of directors to be residents of the country in which the FA conducts its business so that it is considered a resident there under the common law test.   Common Criteria of Residency   There is no bright-line test for establishing where central management and control of a corporation is exercised. All relevant facts and circumstances have to be considered over the entire time period of the corporation's existence such as: 1) Where do the majority of the directors reside? While not determinative, it will likely be factually easier to evidence central management and control in being exercised the country the directors live. Should the board have Canadian resident directors, they should physically attend board meetings in the foreign country, and not remotely via phone or video conference. 2) Is there documentation to support board meetings? Board meetings should be documented, and during such meetings, the board of directors, should exercise its control and make decisions relating to the company's operations and general policies such as investment, financing and dividend payments. Being able to form a functioning board in the country where the FA carries on business can be very challenging for Owner-Managed Businesses (OMBs), especially those that may be in the early stages of expanding and do not have the financial resources nor the need to engage foreign directors. Further, most entrepreneurs and business owners are very heavily involved in the strategic management of their businesses and consider the decision to expand abroad to be significant and are often hesitant to give up any control of their foreign operations (to either employees in the local jurisdiction or independent directors who reside there). As a result, consideration must be given to whether or not residency of the FA can be properly maintained outside of Canada, as this will impact the appropriate structure. For example, if there is concern that the US subsidiary will be considered to be a resident of Canada under the common law test (because the sole director is the Canadian resident owner-manager who makes most of the strategic decisions in respect of the US corporation while in Canada), consideration should be given to forming a US C-corporation (or regarded LLC) so that the corporate tie-breaker rule in the Treaty can be invoked. The Treaty tie-breaker rule provides that where a company is considered a resident of Canada and also a resident of the US, it is treated as resident only of the US based upon its place of incorporation. It is important to note that not all of Canada's tax treaties contain a place of incorporation "treaty-tie breaker rule." One such example is Canada's tax treaty with the UK, where the CRA could take the position that a UK subsidiary that is incorporated under the laws of the UK and operates solely in the UK is a resident of Canada because its central management and control is exercised in Canada. Absent Competent Authority resolution concluding on UK residency only, the UK subsidiary could be subject to Canadian income tax on its worldwide income together with the requisite Canadian income tax filing and reporting obligations.       Act Now To Get Our Value Pricing Adjustment on Audit and Review Engagements For Your Business     Mind and management[3] Mind and management and therefore residency in Canada from a common law perspective can result in adverse consequences under the exempt surplus regime. In order to have business income added to exempt surplus, the foreign affiliate, in this case, USCo, must be resident in a treaty country under Canada’s common law test.   The concern is that by having mind and management in Canada, USco’s business income will be added to taxable surplus rather than exempt surplus with the possible additional tax payable on the repatriation of a dividend.   2.  US Sourced-based income Unlike the taxation of non-business items, the United States seeks to tax business income on a net basis. The United States calculates this tax on a foreign corporation's net taxable income that is "effectively connected" with the "conduct of a trade or business" in the United States (both terms are analysed below). Therefore, two things are needed in order to be taxable in the United States on business income: (1) a US trade or business and (2) the income must be effectively connected with the conduct of that US trade or business. In most cases, it is easier to determine whether the income a person earns is from US sources than it is to determine whether the US source income is from a trade or business.[4] The following are general income sourcing rules set out in the US Internal Revenue Code (the Code):

Interest. The United States generally sources interest to the residence of the debtor. Interest paid by residents of the United States constitutes US source income, while interest paid by foreign residents or foreign corporations is foreign source income.

Dividends. In the case of dividends, the United States generally says the source is to the place of incorporation of the payor. Distributions paid by US corporations generally constitute US source income and distributions paid by foreign corporations is foreign source income.

Personal Services. The United States sources income from personal services to the place where the taxpayer performs those services. Generally, where a person performs services wholly in the United States, those services are US source income.

Rentals and royalties. The location, or place of use of the leased or licensed property should determine the source of rents for US federal income tax purposes. Rents or royalties generated from property located in the United States, or from any interest in such property, is US source income.

Sale of real property. The location of real property on which a taxpayer realizes gains, profits, or other income will dictate the source of that gain, profit, or other income. Therefore, gains, profits, and income generated from an interest in real property located in the United States is US source income.

[3] Expanding to the U.S The Right Way – Know Before You Go, Canadian Tax Foundation, Catherine A. Brayley, Sidhartha Rao. [4] US Tax Treatment of a Canadian Company’s Cross-Border Business – Whitestorm Drains Case Study, Canadian Tax Foundation, Kevin Duxbury.    

Sale or exchange of inventory property. Generally, the United States sources gains, profits, and income from the purchase and sale of inventory propertyentirely from the country where the taxpayer sells the property. The sale of inventory property generally occurs at the place where the seller transfers its rights, title and interest in the property to the buyer.

  Conclusion   There are many considerations relevant in the process of considering whether or not to expand to the U.S, and if so, how to structure that expansion.  The above discussion is not exhaustive, and care should be taken to ensure that the expansion is done in such a way as to facilitate the tax, operational compliance needs of the Canadian parent corporation. Nicholas Kilpatrick is a partner with the accounting firm of Burgess Kilpatrick and specializes in tax structuring and business development for his small and medium business sized clients.  Please visit our website at www.burgesskilpatrick.com.        

      Leading Tax Advice Call Nicholas Kilpatrick 604-612-8620   Growing Canadian businesses searching for new markets are conducting business on a multinational level. The United States, being Canada's largest trading partner is the country many businesses are seeking first to expand to. Since more businesses are expanding into the United States, Revenue Canada and the I.R.S. have increased audit activity of cross-border transactions. In order to ensure that companies are taxed on their cross-border activity there has been a vast increase in the cross-border tax compliance requirements for businesses, and large penalties to ensure compliance with the new and existing rules. It is imperative that businesses are aware of these rules in order to minimize tax costs as well as to maximize profits and cash flows. There are a significant number of new rules that require information disclosure only. This is however, not to be taken lightly, because the penalties attached to non-filing of this information can be as much or more than the tax bills that many companies pay. When businesses expand into the US they often start up with very minimal presence in the US, and, as they expand and grow, this activity increases. There are no US tax or compliance requirements if there is no US formal business presence or business structure. Under US tax law, Canadian companies are subject to US tax on any US source income which is "effectively connected with the conduct of a trade or business within the U.S". This term is not defined in the US Internal Revenue Code ("I.R.C."). However, the US courts have tended to define "the conduct of a trade or business in the United States" as some type of on-going activity. The Internal Revenue Service ("I.R.S.") has defined trade or business to be any activity beyond the mere receipt of income and payment of expenses. Therefore in order to avoid US compliance requirements, there must be no US business activity such as sales representatives or agents in the US, inventory in the US, marketing activity in the US, or regular customer visits in the US US Trade or Business but no US Source Income While foreign taxpayers are subject to US tax if they have a US trade or business, this income must be US sourced income to be subject to tax in the US For example, there is a US trade or business if salesmen travel to the US and conclude sales but the income is Canadian sourced if title to the goods sold passes to the purchaser in Canada. US tax or compliance filings are not required if there is a US trade or business but there is no US source income. The I.R.C. defines various sourcing rules.  For example, generally, the income from retail sales is sourced where the rights and title pass to the buyer. Service income is sourced based upon where the service is performed. Sales of manufactured inventory is allocated based on the location of manufacturing and sales activity. | Doing Business in the US - US Business Activity Without Permanent Establishment US domestic law requires Canadian companies to pay tax in the US if they have US source income "effectively connected with the conduct of a trade or business within the United States". The Canada-United States Income Tax Convention, 1980 ("the Treaty") overrides the US domestic law such that the Canadian company is taxable on US income only if it has a permanent establishment in the US  It is imperative to understand the concept of permanent establishment because permanent establishment defines when tax is levied in the US Even though a Canadian corporation may have a trade or business in the US and is liable for tax pursuant to the I.R.C., the Treaty overrides the obligation of the I.R.C. Recently the US introduced new rules that require many Canadian-based corporations to file US tax returns disclosing the nature and extent of their activities in the US and explain why they       are exempt from US tax on business profits in the US  The need to file arises in situations where the corporation would be subject to tax under US domestic law but is exempt, or taxable at a reduced rate, under the Treaty.[1] Historically speaking, most Canadian businesses have a tacit aversion to filing US returns unless they have to. The new compliance provisions must be carefully studied because the US imposes a penalty of up to $10,000 per item of income plus the disallowance of business deductions if the corporation is subsequently determined by the I.R.S. to be engaged in a US business and has not timely filed its US return.  Timely means within 18 months of the date the return is due. Canadian companies can undertake certain US business activities without the imposition of US tax, however, Treaty disclosure may be required. For example, US activity including participation at trade shows, US direct mail or phone advertising, salesmen visiting customers in the U.S but without having contracting authority in the US, final sales orders that are negotiated in Canada, inventory that is maintained only in Canada and ownership of tangible property sales transfers in Canada, allows a Canadian company to do business in the US with no US federal tax liability. Also the Canadian company can use franchises or non-exclusive distributorships on a commission basis if they do not function as dependent agents with contracting authority on behalf of the Canadian company. Inventory can be in the US with no federal tax liability. However, although there may be no US tax liability some of these circumstances may require treaty-based disclosure. In addition, there may be state tax issues. One of the most difficult problems is determining when a treaty-based return is necessary. Most Canadian businesses do not know whether they would be taxable in the US were it not for the Treaty. For small and medium sized businesses, the following questions should be asked to determine whether treaty-based filing is required. This is not all inclusive but it covers some of the more common situations. Does the corporation:

• Have sales representatives based in the US, whether they are dependent or independent?
• Have Canadian-based sales representatives or officers who travel in the US?
• Have exclusive sales agents in the US?
• Provide technical maintenance or similar services to US customers?
• Have inventory in the US in a public warehouse, showroom, etc.?
• Attend trade shows in the US?
• Maintain a purchasing office in the US? |
• Have any joint ventures in the US?
• Provide management, accounting or other administrative services to a US affiliate?

If the answer to any of these questions is "yes" a US treaty-based return may need to be filed. This is because US domestic law would, without the Treaty, subject the Canadian business to U.S federal tax. While many Canadian companies seem reluctant to become embroiled in these new US compliance requirements, the risk of penalties for not doing so is now extremely onerous.     [1] Canadian and U.S Tax Compliance Issues For Doing Business In The U.S, Canadian Tax Foundation, Brenda J. Lowey.       Act Now To Get Our Value Pricing Adjustment on Audit and Review Engagements For Your Business   Compliance Requirements "Treaty-Based" Return A US "treaty-based" return is required if the Canadian company has US source income effectively connected to a US trade or business but no US permanent establishment. The following must be filed with the I.R.S. Philadelphia, P.A. 19255.

Form 1120F US, Income Tax Return of a Foreign Corporation - complete only the information section including T.I.N.(taxpayer identification number) and sign

Form SS-4 is used to apply for T.I.N.

Attach Form 8833, "Treaty-Based Return Disclosure Under Section 6114 or 7701(b)" to 1120F. Form 8833 requires an explanation of the treaty-based return position taken, including a brief summary of the facts on which it is based. Also, include the nature and amount or estimate of gross receipts, and each separate gross payment for which the Treaty benefit is claimed. For example, the statement to indicate that there is no US permanent establishment would include that there are gross receipts from sales in the US, the amount of these receipts, and a description of the facts that support that there is no US permanent establishment. An example would be the fact that sales are made by an independent agent.

  Protective "Treaty-Based" Return An example of when a "Protective "Treaty-Based" Return" might be filed is if, after reviewing the Treaty, the Canadian company is uncertain whether its US activities constitute a US permanent establishment. As indicated, the US does impose tax | if there is a permanent establishment. The protective treaty-based return would be prepared as follows:

Form 1120F and Form 8833 are filed; a statement is made that it is a protective filing stating that the corporation does not have a US permanent establishment and therefore is not subject to US tax, but is filing the protective statement to ensure entitlement to deductions and credits attributable to US source income if the income were taxable in the US

This protective filing starts the statute of limitations for that taxation year. There is no statute of limitations on an I.R.S. assessment if no income tax return is filed. Once filed, the federal statute of limitations is 3 years.

This filing also ensures entitlement to US deductions because if a timely return is not filed in the US, there is no entitlement to deductions or credits. "Timely filed" means within 18 months of the original due date not including extensions.

Filing Deadlines The timing for filing treaty-based returns for Canadian corporations is the 15th day of the sixth month after the taxation year end. Therefore, for a December year end, the filing deadline is June 15th. A return is considered filed when postmarked by the US postal service.   Late Filing Late filings should be done to meet compliance requirements, even if filed more than 18 months late. Penalties for Non-Filing of Treaty-Based Information Businesses receiving payments or income items from US sources during the taxable year that do not exceed US $10,000 are exempt from filing a treaty-based return. Businesses over that limit may face steep fines for failure to file such a return of up to US $10,000 for each payment or each item of income from US sources. State Income Tax Requirements

Most US states impose income tax. State taxation is imposed if there is any nexus with the state. Nexus can be a much lower threshold than permanent establishment, which is the threshold that is required to establish tax liabilities for US federal purposes. Therefore, each state's code must be carefully studied.

Most states base their tax on US federal adjusted gross income or federal taxable income. If there is a nexus with the state then the state tax calculation generally begins with federal taxable income.

Some states such as California and New York do not use federal taxable income as a tax base. These states impose state tax on the amount of the company's worldwide income allocatable to the state. The allocation is based on the amount of gross sales, payroll and assets which are attributable to or located in the state. Therefore, even though there may be no US source income from sales in that state, there may be a requirement to file state tax returns. This allocation on world-wide income is referred to as a "unitary tax." This requires the allocation of worldwide income of the Canadian corporation within and without the state based on sales, payroll and assets, as opposed to apportioning US income only. This can result in the state imposing tax on the Canadian corporation even in years when the US operations have a loss. There have been court cases in the US that have challenged the constitutionality of the unitary tax. There is in most cases prescribed relief to elect to be taxed only on state activity.

Some states that do not have income tax have a franchise tax, which is like an income tax for companies doing business in the state. For example, Texas has a franchise tax. Some states have income taxes and franchise taxes as well as capital taxes.

Filing deadlines, extensions, and payment dates for states need to be individually researched for each state in which the company is doing business. They do not automatically follow federal law. |

  Canadian Tax Requirements Federal tax

If there is no US permanent establishment, then tax is computed in Canada. The provincial abatement applies to taxable income of the Canadian company if there is no US permanent establishment. The taxable income allocated to a province is eligible for a 10% tax reduction federally. This same income amount is then subject to provincial tax.

The Canadian company may allocate some income to the US if US state tax is imposed. The income allocated to the US in this circumstance would not be eligible for the provincial abatement. Also the Canadian provinces would not likely impose tax on such income. The allocation of income to a province is determined by the Regulations in Part IV of the Income Tax Act (the Act). These Regulations define permanent establishment and then allocate income among the permanent establishments by a formula dependent upon sales and wages. Usually there is not a conflict when there is a permanent establishment under the Treaty, but there may be times when there may be a permanent establishment according to provincial allocation regulations but not under the Treaty.

  Canadian foreign tax credits may be used to reduce Canadian federal tax payable if US state tax is imposed. Provincial Tax

US business income is included in the provincial base for tax calculation if there is no US permanent establishment.

The Canadian company's taxable income is allocated to provinces based on gross sales and payroll attributable to that province. Retail and wholesale sales revenue is allocated based on the location of the individuals negotiating the sales. Sales of manufactured goods are allocated to the province performing the sales activities and manufacturing activities.

If both a Canadian province and a US state tax a sale, there are no Canadian provincial foreign tax credits for US state tax paid. |

    Conclusion   There are a myriad of Canadian and US tax compliance issues for Canadian businesses expanding into the US A review of at least the items identified in this paper will assist businesses to identify the requirements and to make a calendar of important filing dates. Planning ahead will ensure that proper business structures have been considered, and that all required compliance filings are made to avoid unnecessary and expensive penalties. It will also help to plan for tax compliance issues for Canadian employees spending time or transferring to the US.     Nicholas Kilpatrick is a partner with the accounting firm of Burgess Kilpatrick and specializes in tax structuring and business development for his small and medium business sized clients.  Please visit our website at www.burgesskilpatrick.com.  

      Leading Tax Advice Call Nicholas Kilpatrick 604-612-8620   Growing Canadian businesses searching for new markets are conducting business on a multinational level. The United States, being Canada's largest trading partner is the country many businesses are seeking first to expand to. Since more businesses are expanding into the United States, Revenue Canada and the I.R.S. have increased audit activity of cross-border transactions. In order to ensure that companies are taxed on their cross-border activity there has been a vast increase in the cross-border tax compliance requirements for businesses, and large penalties to ensure compliance with the new and existing rules. It is imperative that businesses are aware of these rules in order to minimize tax costs as well as to maximize profits and cash flows. There are a significant number of new rules that require information disclosure only. This is however, not to be taken lightly, because the penalties attached to non-filing of this information can be as much or more than the tax bills that many companies pay. This third article in our series on Canadian Outbound investment into the U.S analyzes the various structures that can be utilized within the corporate structure, as well as repatriation issues when bringing income back into Canada from the U.S.  Another article will analyze the tax implications of these various structures.  

Repatriating Profits from the U.S.

  In this part of the paper we will consider the means by which profits can be repatriated from USco to Canco: (i) dividends, (ii) interest, (iii) royalties, and (iv) management fees. In each case, it is assumed that USco will be eligible to use the Treaty. If USco is ineligible to use the Treaty, the rate of withholding tax will be 30%. i.  Dividends If the profits of USco are distributed as a dividend, the dividend will be subject to U.S. withholding tax at the rate of 30% subject to reduction under the Treaty.   If USco is subject to the Treaty, the rate of withholding tax on dividends will be either 15% or 5% depending on the ownership of the USco’s shares by Canco. Because in our situation USco is a wholly-owned subsidiary of Canco, the rate of withholding tax will be 5%. It is important to note that unlike the situation in Canada, it is not possible for a U.S. company with either current or accumulated earnings and profits to return capital without giving rise to withholding tax. For U.S. tax purposes, a distribution will be treated as a dividend subject to withholding if there are current or accumulated earnings and profits and to the extent the distribution exceeds these amounts, the distribution will be treated as a return of capital which will reduce Canco’s basis in shares of USco.   Lastly, if the distribution exceeds Canco’s basis in USco’s shares, the distribution will result in a gain from the exchange of property for U.S. federal tax purposes. The Canadian tax treatment of the dividend will depend upon the surplus account from which the dividend is paid. Where the business is an active business that is conducted in the U.S. by USco the dividends will likely be considered to be paid out of the exempt surplus account. In this case, the Canadian shareholder will be entitled to a deduction in computing income.  Where the dividend is paid out of exempt surplus, there will be no tax relief for the withholding tax that was paid.   Where the dividend would be paid out of exempt surplus, the incidence of Canadian tax can be deferred by deferring the payment of dividends.     ii.Interest Similar to dividends, the default U.S. federal withholding tax is 30% on Interest paid by USco to Canco.   However, if Canco provides USco with a completed IRS Form W-8BEN-E, Certificate of Status of Beneficial Owner for U.S. Tax Withholding and Reporting (Entities) the rate of withholding tax can be reduced to zero. iii. Royalties If USco uses tangible or intangible property owned by Canco, chances are that the use of this property in the U.S. will result in royalties being paid by USco to Canco. Like interest and dividends, the default withholding tax rate is 30% but can be reduced to 10% of the gross amount of the royalties if IRS Form W-8BEN-E is provided to USco by Canco.   Certain types of royalty payments for the license of computer software to USco may be eligible for 0% withholding tax. iv.  Management and Other Fees If Canco provides management and support to USco, a management fee paid to Canco would be appropriate to consider. For a long time, it was common to see management fees to Canco that happened to leave US$50,000 or less of taxable income in USco. Oddly, this US$50,000 taxable income amount coincided in a reduced 15% U.S. federal tax rate prior to 2018. Given the relative parity between the U.S. and Canada with respect to corporate tax rates, the incentive to strip earnings in the U.S. via management fees has diminished significantly.   Management fees are not subject to U.S. federal withholding tax because they are considered payments for services. Services are sourced to where those services are rendered and under the presumption that Canco’s management fees relate to services rendered in Canada, the management fees are sourced to Canada.  The exception to this would be where Canco provides its services through a permanent establishment in the U.S.   Employees of Canco Working in the U.S.  

Compliance obligations

When Canco expands to the U.S., it may require key Canadian resident-employees to travel and work in the U.S. to assist with business expansion. It is common to neglect to consider the payroll and personal tax considerations for Canco and its employees that work in the U.S.   The remuneration paid to Canco’s employee for services rendered in the U.S. is sourced to the U.S. under U.S. domestic tax law.   Therefore, the wages paid to Canadian-resident employees are subject to U.S. federal payroll withholdings.   Under U.S. domestic tax law, wage withholdings are not required where:

• The non-U.S. employee is present in the U.S. for less than 90 days in the tax year;
• Total wages are less than US$3,000; and
• The services are rendered for a non-U.S. corporation that is not engaged in a U.S. trade or business.

As is evident from the conditions above, this is a very narrow exception. In almost every instance that Canco sends an employee to the U.S., it will be engaged in a U.S. trade or business.       Act Now To Get Our Value Pricing Adjustment on Audit and Review Engagements For Your Business     While the U.S. domestic tax law exception is quite narrow, the Treaty provides additional relief if either of the following conditions are met:

• US source remuneration is less than US$10,000; or
• The employee is present in the U.S. for less than 183 days in any 12-month period and the remuneration is not borne by a permanent establishment in the U.S. nor a resident of the U.S.

If the Treaty exception applies, the employee must complete and provide Canco with IRS Form 8233, Exemption From Withholding on Compensation for Independent (and Certain Dependent) Personal Services of a Nonresident Alien Individual.  Canco will then need to file this form with the IRS.   If instead USco or Canco’s U.S. Branch bears the cost associated with the remuneration, the Treaty exception will likely not apply and employee’s wages will be subject to U.S. payroll withholding tax. Notwithstanding the potential U.S. federal income tax associated with employee’s wages sourced to the U.S., Canada should allow a foreign tax credit for the final U.S. federal tax liability from employee’s IRS Form 1040NR, U.S. Nonresident Alien Income Tax Return. 2.  Personal Tax Considerations for the Employees If Canco’s employee’s wages are subject to US federal income tax because those wages are borne by USco or by Canco’s U.S. branch, he or she will be required to file IRS Form 1040NR, U.S. Nonresident Alien Income Tax Return to report and pay U.S. federal income tax on those wages. Things become more complicated where Canco’s employee spends more than 121 days on average in the U.S. for any purpose for the current year and the 2 preceding years.   If this happens, then the individual will be considered a U.S. resident for U.S. federal tax purposes subject to U.S. federal tax on his or her worldwide income. However, he or she can nevertheless be considered a non-resident if the following conditions are met:

• The individual is present in the U.S. for fewer than 183 days in the U.S. in the current year;
• The individual maintains a tax home in a foreign country during the current year; and
• The individual has a closer connection to a single foreign country in which a tax home is maintained than to the U.S.

More complicated still is where the employee spends more than 182 days in the U.S. in the current tax year as the employee will be ineligible to file the Closer Connection Exception Statement. Instead, the only exception from U.S. worldwide taxation is relief under the Treaty. The Treaty contains tie-breaker provisions in case an individual meets the residency requirements in both Canada and the U.S. under each jurisdiction’s domestic law. Assuming the individual remains a Canadian resident for tax purposes under Canadian domestic tax law, the following test from the Treaty is applied: 1) The individual will be a resident of the country in which he or she has a permanent home available to them; 2) If a permanent home is available in both countries, the individual be considered a resident where his or her centre of vital interests are; 3) If the former test is not dispositive, then the individual will be a resident in the country where his or her habitual abode is; and 4) If the individual has a habitual abode in both countries, where he or she is a citizen. The employee would need to file an IRS Form 1040NR and would be subject to most of the international informational disclosures that would apply to a U.S. person.   Compliance in the U.S.   Often Canadian companies are surprised at the complexity associated with U.S. compliance burdens for relatively straightforward business activity. Not only are there requirements to file U.S. federal income tax returns and related disclosures but there can be state and local tax returns that require filing as well. Failure to timely file certain information disclosures can result in significant penalties being assessed in excess of $10,000 per return. Canco’s US Branch Assuming Canco is operating in the U.S. through a branch in California, the following tax returns and disclosures may apply:

• IRS Form 1120-F, U.S. Income Tax Return of a Foreign Corporation – Due 3.5 months after year-end;
• IRS Form 5472, Information Return of a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business – Attached to IRS Form 1120-F;
• IRS Form 8833, Treaty-Based Return Position Disclosure Under Section 6114 or 7701(b) – Attached to IRS Form 1120-F;
• IRS Form 1099-MISC, Miscellaneous Income – Due February 28th following the calendar year for which a return applies;
• California Form 100, California Corporation Franchise or Income Tax Return – Due 3.5 months after year-end.

USco’s Filing Obligations If instead of a branch, Canco has formed USco which has nexus in California, the following tax returns and disclosures may apply:

• IRS Form 1120, U.S. Corporate Income Tax Return – Due 3.5 months after year-end;
• IRS Form 5472 – Attached to IRS Form 1120;
• FinCEN Form 114, Report of Foreign Bank and Financial Accounts (FBAR)– Due April 15th and filed electronically;
• IRS Form 1099-MISC – Due February 28th following the calendar year for which a return applies;
• IRS Form 1042-S, Foreign Person’s U.S. Source Income Subject to Withholding – Due March 15th;
• California Form 100 – Due 3.5 months after year-end.

  U.S. State Tax Considerations   It is common for Canadian companies to conclude that since they do not have permanent establishments in the U.S. and are therefore not subject to U.S. federal income tax, their only tax obligations are in Canada. Unfortunately, these conclusions would be very premature. The various states in the U.S. are not signatories to the Treaty. Accordingly, states are not bound to concepts of “permanent establishments” that may otherwise limit their ability to impose an income tax on an out-of-state taxpayer.  States are restricted, by the U.S. Constitution and legislation passed by the U.S. Congress, from imposing an income tax on an out-of-state taxpayer that lacks “substantial nexus” with a specific state.   Conclusion   There are a myriad of Canadian and US tax compliance issues for Canadian businesses expanding into the US A review of at least the items identified in this paper will assist businesses to identify the requirements and to make a calendar of important filing dates. Planning ahead will ensure that proper business structures have been considered, and that all required compliance filings are made to avoid unnecessary and expensive penalties. It will also help to plan for tax compliance issues for Canadian employees spending time or transferring to the US.     Nicholas Kilpatrick is a partner with the accounting firm of Burgess Kilpatrick and specializes in tax structuring and business development for his small and medium business sized clients.  Please visit our website at www.burgesskilpatrick.com.      

      Leading Tax Advice Call Nicholas Kilpatrick 604-612-8620 Growing Canadian businesses searching for new markets are conducting business on a multinational level. The United States, being Canada's largest trading partner is the country many businesses are seeking first to expand to. Since more businesses are expanding into the United States, Revenue Canada and the I.R.S. have increased audit activity of cross-border transactions. In order to ensure that companies are taxed on their cross-border activity there has been a vast increase in the cross-border tax compliance requirements for businesses, and large penalties to ensure compliance with the new and existing rules. It is imperative that businesses are aware of these rules in order to minimize tax costs as well as to maximize profits and cash flows. There are a significant number of new rules that require information disclosure only. This is however, not to be taken lightly, because the penalties attached to non-filing of this information can be as much or more than the tax bills that many companies pay. This third article in our series on Canadian Outbound investment into the U.S analyzes the various structures that can be utilized within the corporate structure, as well as repatriation issues when bringin income back into Canada from the U.S.  Another article will analyze the tax implications of these various structures.   Types of Business Entities in the U.S. and How They are Treated from a Canadian Perspective   If a Canadian company concludes that it requires a U.S. legal entity, the next decision is choosing the appropriate entity for its particular business opportunity. The following discussion is not meant to be an exhaustive list of each type of business entity available to Canadian companies; rather, it will focus on the most common business entities encountered in a Canada-U.S. cross-border context.  

 Subchapter “C” Corporations

  A reference to a corporation in the U.S. is likely a reference to a “C” Corporation. The term “C” Corporation comes from Subchapter C of the IRC which contains IRC sections 301 to 385. Corporations are formed under the laws of the U.S. state in which they are organized however; the reference to “C” dictates how that corporation will be taxed pursuant to the IRC. A “C” Corporation is the only business entity discussed here that is a taxable entity which is to say that the corporation, rather than its shareholders, pays tax on its income. Barring unusual circumstances, shareholders of “C” Corporations are not liable for the debts of the corporation. The biggest distinction between how “C” Corporations are taxed and how Canadian corporations are taxed is that the corporate profits of “C” Corporations are subject to double-tax. Rather than an integrated tax system where shareholders get a credit for taxes paid by the corporation they own, “C” Corporations first pay a corporate level tax and shareholders then pay tax on after-tax profits distributed to them with no consideration for the corporate level taxes already incurred. This double-tax cost of operating as a “C” Corporation makes the effective tax rate of a “C” Corporation more than that of a fiscally-transparent entity like a partnership. As noted previously, a “C” Corporation will be subject to tax in the U.S. If it is also a resident of Canada (perhaps because mind and management is in Canada), it will be treated as a resident in the U.S. based on its place of incorporation.  If the mind and management is in Canada; however, there may be adverse tax consequences in respect of the availability of the exempt surplus regime. It will be important to ensure that the mind and management of the “C” Corporation is not in Canada. 2.     Subchapter “S” Corporations   In addition to “C” Corporations, a corporation organized under state law can elect to be taxed under Subchapter S of the IRC which contains IRC sections 1361 to 1379. “S” Corporations are fiscally transparent entities unlike “C” Corporations, so the shareholders of an “S” Corporation are responsible for the tax burden of its profits or losses. Furthermore, unlike “C” Corporations, there are several requirements that need to be met in order for a corporation to elect to be taxed as an “S” Corporation for U.S. federal tax purposes. One such requirement is that all shareholders must be U.S. citizens, lawful permanent residents or U.S. residents for tax purposes. Another requirement is that all shareholders must be natural persons and cannot be other “C” Corporations. Because “S” Corporations are rarely used in a cross-border context, further implications of “S” Corporations will not be addressed. 3.  Limited Partnerships   Besides corporations, limited partnerships and similar derivatives of limited partnerships are common business entities in the U.S. Over the last 25 to 30 years, limited partnerships have become less common outside of professional services industries like law firms and accounting firms. Instead, limited liability companies, discussed below, have become ubiquitous. Limited partnerships are created under partnership pursuant to state statutes. Unlike “C” Corporations, limited partnerships are fiscally transparent and the partnership itself is a conduit to determine the allocation of partnership attributes to its partners. Limited partners generally have limited liability with respect to the debts of the partnership but this comes as a trade-off as limited partners risk losing this cloak of protection if they actively participate in management of the limited partnership. Lastly, every limited partnership is required to have a general partner that has unlimited liability for the debts of the partnership. Typically, where limited partnerships are still found, the general partner is another limited liability entity like a limited liability company or corporation. In addition to limited partnerships, variants of limited partnerships like limited liability partnerships (LLPs) and limited liability limited partnerships (LLLPs) have sprout up across the various state partnership acts. These entities are all taxed the same for U.S. federal tax purposes but afford various degrees of limited liability for partners. LLPs are generally reserved for professional service entities and prevent the actions of one limited partner being imputed on the other limited partners and LLLPs provide limited liability protection for general partners. From a Canadian perspective, Canco would be subject to tax on its shares of the profits of a limited partnership. The CRA has taken the position that both LLPs and LLLPs should be treated as corporations for Canadian tax purposes.  The difference in tax treatment for Canadian purposes and U.S. purposes can result in adverse tax consequences.   4.  Limited Liability Companies (LLC)   Since the early 1990’s when they started to appear under state statutes LLCs have become one of the most common business entities used to carry on a business. LLCs offer the benefits of flow-through of profits and one layer of tax with benefits of limited liability for all owners including the managing partners. LLCs with a single-owner are treated as disregarded entities for U.S. federal tax purposes. A disregarded entity is an entity with one owner that passes-through profits and losses and is not the beneficial owner of the assets it owns.     Act Now To Get Our Value Pricing Adjustment on Audit and Review Engagements For Your Business   Rather, the owner of the LLC is treated as owning the assets and income of the disregarded entity. Moreover, disregarded entities do not have separate income tax return filing requirements unlike other fiscally transparent entities like partnerships. The CRA has stated that where a Canadian resident is the sole member of a disregarded LLC which carries on business in the U.S. and its mind and management is in Canada, there is no relief from double taxation under the Treaty.   Moreover, if LLC treated as a resident of Canada, it would generally need to file a Canadian corporate tax return. For this reason the U.S. business should not be carried on by an LLC.   Other issues:  

Check-The-Box

  Introduced in 1996, the “Check-the-Box” Regulations allow “eligible entities” to elect their tax treatment for U.S. federal tax purposes. Entities organized as partnerships or disregarded entities may make an election to be taxed as a “C” Corporation for U.S. federal tax purposes while retaining their status as partnerships or LLCs under state law. Once an election is made under these Regulations, it is binding for at least 60 months. Often when organizing a corporate entity in the U.S., one will find it easier and slightly less expensive to organize an LLC rather than a corporation. Thus, an LLC can be formed under state incorporation/organization statutes but have a different classification for U.S. federal tax purposes. Should an LLC be formed with the intent to elect to be taxed as a “C” Corporation, IRS Form 8832, Entity Classification Election must be filed within certain prescribed time limits in order for the “C” corporation status to be effective from the LLC’s organization date.     2.  Disregarded Limited Partnerships   Disregarded limited partnerships are limited partnerships where the limited partner is the sole limited partner and owns 100% of the general partner which is itself an LLC. In this scenario, the general partner usually owns a nominal interest in the limited partnership (1%). Under this arrangement, the same limited partner is treated as owning 100% of the LP units because as discussed above the owner of disregarded entity is treated as owning the disregarded entity’s asset which solely consists of the 1% limited partnership interest. The IRS has ruled that this arrangement will be treated as a disregarded entity for U.S. federal tax purposes which means that the limited partnership is not required to file a U.S. partnership return of income. Disregarded limited partnerships can be an alternative to using LLCs. The entities are formed as limited partnerships under state law with a general partner. Accordingly, it should be considered to be a partnership for Canadian tax purposes with the result that all of the income will flow through as would be the case if Canco operated as a branch. The CRA should view these as flow-through entities rather than corporations the latter of which causes significant issues in a cross-border context.   3.  How to Finance the U.S. Operations   Should USco be funded by debt, equity or a combination of debt and equity? The manner in which Canada and the U.S. deal with debt makes matters complicated. There is always an incentive to finance USco with debt rather than equity because with the former the principal can be returned to the lender tax-free, interest payments create deductions against taxable income and interest paid by Canco to USco is generally not subject to U.S. federal withholding tax. On the other hand, if a capital contribution or equity is used to finance the U.S. subsidiary, there is no deduction for dividends paid to   shareholders and there is a 5%/15% U.S. federal withholding tax for dividends paid to Canadian resident shareholders. If the funding with debt, should the loans to USco bear interest? If the loans are non-interest bearing, consideration must be given to the possible application of section 17. If it applies, section 17 will impute interest at the prescribed rate on an amount that is owing for more than a year by the non-resident to a Canadian resident corporation where the interest on the debt is less than a reasonable rate for the period. In the case of a USco that is owned by Canco, it is possible that the exception in subsection 17(8) would apply. This exception applies where the loan is made to a controlled foreign affiliate and the indebtedness is used for the purpose of earning income from an active business or income that is deemed to be active business income. Attention will have to be paid to the use of the indebtedness to ensure that this test is met. If to ensure that the shares of Canco meet the test for the LCGE, the shares are held in a Canadian entity that is separate from Canco, it is possible that section 17 will apply because the exception in subsection 17(8) would not be met. In addition to Canadian tax considerations, further thought should be given to the U.S. tax implications of introducing debt to a U.S. subsidiary. Specifically, the two most common issues associated with financing U.S. operations with debt are: 1) whether the debt might be recast as equity and 2) whether the interest accruing or paid will be deductible for U.S. federal tax purposes.   Conclusion   There are a myriad of Canadian and US tax compliance issues for Canadian businesses expanding into the US A review of at least the items identified in this paper will assist businesses to identify the requirements and to make a calendar of important filing dates. Planning ahead will ensure that proper business structures have been considered, and that all required compliance filings are made to avoid unnecessary and expensive penalties. It will also help to plan for tax compliance issues for Canadian employees spending time or transferring to the US.     Nicholas Kilpatrick is a partner with the accounting firm of Burgess Kilpatrick and specializes in tax structuring and business development for his small and medium business sized clients.  Please visit our website at www.burgesskilpatrick.com.      

      Leading Tax Advice Call Nicholas Kilpatrick 604-612-8620   Growing Canadian businesses searching for new markets are conducting business on a multinational level. The United States, being Canada's largest trading partner is the country many businesses are seeking first to expand to. Since more businesses are expanding into the United States, Revenue Canada and the I.R.S. have increased audit activity of cross-border transactions. In order to ensure that companies are taxed on their cross-border activity there has been a vast increase in the cross-border tax compliance requirements for businesses, and large penalties to ensure compliance with the new and existing rules. It is imperative that businesses are aware of these rules in order to minimize tax costs as well as to maximize profits and cash flows. There are a significant number of new rules that require information disclosure only. This is however, not to be taken lightly, because the penalties attached to non-filing of this information can be as much or more than the tax bills that many companies pay. The second part of this series on doing business in the U.S goes through various methods to undertake business operations in the U.S   Canadian Structural Considerations   This section of the paper assumes that the U.S. business will be operated as either a branch or a separate legal entity will be formed. Having understood what is meant by expanding to the U.S. the next step is to consider the structure of that legal entity.  In considering how to structure the expansion to the U.S. from a Canadian tax perspective, a number of issues should be considered: (i) management and strategic direction; (ii) status of Company as a small business corporation; (iii) the ability to restructure on a tax-deferred basis and (iv) investments by Canco in real estate situated in the U.S. Each of these factors will be addressed in turn.

Management and Strategic Direction

  Our fact situation indicates that Canco has a sole director and officer. As such, that person both manages and strategically controls Canco. It will be important for your client to consider who will be managing and controlling the strategic direction of the U.S. business and from where that is to take place. The issue of central management and control can affect where the income of the entity/USco will be subject to tax. If the director of USco is a resident of Canada, for example, the risk is that the U.S. entity will be considered to be resident in Canada.  Canco will have to take steps to ensure that USco will not be a resident of Canada. One option is to have a resident of the U.S. manage and control the U.S. entity. Another option would have a number of directors with the majority of the directors present in the U.S. when decisions are made. A further option would be have a Canadian director ensure that those strategic decisions take place in the U.S. Where the manager/director travels to the U.S. to make the strategic decisions there, there would need to be documentation to support the assertion that that is what happened. In addition to travel records, this would include board minutes, resolutions, and proof of execution of contracts and key agreements in the U.S. This would be an additional administrative task that Canco might not be used to undertaking. That being said, provided USco is a “C” Corporation, even if it is found to be both a resident of Canada and a resident of the U.S., the tie-breaker rules in the Treaty should result in USco being a resident of the U.S. on the basis of its place of incorporation. Mind and management and therefore residency in Canada from a common law perspective can result in adverse consequences under the exempt surplus regime. In order to have business income added to exempt surplus, the foreign affiliate, in this case, USCo, must be resident in a treaty country under Canada’s common law test. 41  The concern is that by having mind and management in Canada, USco’s business income will be added to taxable surplus rather than exempt surplus with the possible additional tax payable on the repatriation of a dividend. 2.    Small Business Corporation   In considering how Canco will expand to the U.S., consideration should be given to whether Canco will be a “small business corporation.” What is a small business corporation? First, Canco must be a Canadian-controlled private corporation. Second, all or substantially all of the fair market value of Canco’s assets must be attributable to assets that are (i) used principally in an active business carried on primarily in Canada by the particular corporation or by a corporation related to it; (ii) shares of the capital stock or indebtedness of one or more small business corporations that were at that time connected with the particular corporation or (ii) assets described in (i) and (ii). For this purpose, (i) principally is generally considered to mean more than 50% and is applied on a property-by-property basis;   (ii) all or substantially all is considered by the CRA to mean 90% or more;  and (iii) primarily is more than 50%. In considering how to structure the expansion of the business to the U.S. it will be important to think about the prospect for growth in the U.S. and the relative value of those assets to Canco’s assets. Canco’s status as a small business corporation is essential if Canco’s shareholder wishes to access the lifetime capital gains exemption (LCGE) in respect of “qualified small business corporation shares”  at the time of the disposition or deemed disposition of the Canco shares. If a shareholder or a debtholder realizes a loss and Canco is a small business corporation, the shareholders may be able to treat the loss as an allowable business investment loss   with the result that one-half of the loss may be used to offset any source of income. The so-called corporate attribution rules will not apply if Canco is a small business corporation from the time of the loan or transfer of property.  A 10-year reserve is available in respect of the transfer of shares of a small business corporation to a child.  Depending on the context, Canco must be a small business corporation throughout a period of time or at a particular time.   Act Now To Get Our Value Pricing Adjustment on Audit and Review Engagements For Your Business   In the case of the LCGE, Canco must be a small business corporation at the time the shares are disposed of.  In addition to the point in time test, the corporation must have derived more than 50% of the value of its assets from an active Canadian business for the 24-months prior to the disposition. If Canco operates a branch in the U.S., the assets of the branch, including goodwill, will not meet the definition in (i) and thus will not be an eligible asset. If the value of those assets (together with Canco’s other ineligible assets, such as surplus cash) exceeds 10% of the fair market value of all of Canco’s assets, Canco will not meet the test of small business corporation   and the LCGE will not be available. If instead of operating a branch, Canco proposes to form an entity in the U.S., that entity will not meet the definition in either (i) or (ii) with the result that the value of any equity or debt would not be an eligible asset. If the value of that equity or debt (together with Canco’s other ineligible assets, such as surplus cash) exceeds 10% of the fair market value of Canco’s assets, Canco will not meet the test of small business corporation and the LCGE will not be available. Because the small business corporation status is tested at the time the shares are disposed of, if the ineligible assets comprise more than 10% of Canco’s assets,  steps will need to be taken to remove those assets from Canco or “purify it.” There may be questions as to whether it is even possible to do so. The Canadian tax implications of removing the U.S. assets from Canco will have to be considered. There may be legal and U.S. tax implications and/or impediments to moving the U.S. operations in a separate company. For these reasons, it may be preferable to establish the U.S. business in a Canadian entity that is separate from the Canco. Ideally the U.S. business would not be owned by an individual as there may be U.S. Estate Tax implications.  The incorporation of another Canadian company to own the business will result in additional set-up and maintenance costs and compliance. There will also be concerns about allocating costs from Canco to that entity. 3.  Ability to Restructure on a Tax-Deferred Basis   There may be reasons why consideration should be given to having the U.S. business structured as a branch. For example, the prospect for success in the U.S. is not certain with the result that there is a reluctance to invest the time and money to establish a separate legal entity. It could also be because the branch will initially generate losses which may be used to offset the income of the Canco. If it is determined that it would be beneficial to incorporate the branch, consideration will have to be given to whether this can be effected on a tax-deferred basis from a U.S. or a Canadian tax perspective. From a Canadian tax perspective, there is no ability to effect the transfer of the branch’s assets to USco on a tax-deferred basis because a condition of subsection 85(1) is that the company must be a taxable Canadian corporation. Accordingly, any appreciation in the branch’s assets will be subject to tax in Canada. If there are losses, the losses will be deemed to be nil as a result of the application of the so called stop loss rules. For U.S. federal tax purposes, Canco should be able to rollover its branch assets to USco in exchange for shares of USco if it acquires at least 80% control of the vote and value of USco.  However, if the assets transferred include U.S. situs real estate, nonrecognition may not be available.  One should also consider the Canadian tax implications of having disparate tax basis for assets rolled over to USco where a disposition occurs for Canadian but not U.S. federal tax purposes. For this reason, it is important that consideration be given to the form of the U.S. business and the ownership structure at the outset.   4.  Canco Invests in U.S. Real Estate   Canco that expands to the U.S. via purchase and exploitation of U.S. real estate will be subject to U.S. federal income tax on both the rents and gains when the property is disposed. Rents are either taxed as Fixed, Determinable, Annual, Periodical (FDAP) or income effectively connected (“ECI”) to a U.S. trade or business. Rents which are FDAP are subject to a 30% U.S. federal withholding tax on gross amounts paid.   If rents are effectively connected to a U.S. trade or business, they are taxed on a net basis and at graduated rates.   Gains from dispositions of real estate situated in the U.S. are automatically treated as effectively connected to a U.S. trade or business. The Treaty does not alter the taxation of U.S. real estate as it defers to the source country for the first right to tax the income which is consistent with U.S. domestic tax law.  The Treaty can expand on the definition of real property beyond what U.S. domestic law would otherwise provide. 5.  Income for U.S. Purposes is Not the Same as Income for Canadian Tax Purposes   As one might expect, there are differences between U.S. and Canadian tax laws that will affect how U.S. taxable income is translated in Canada. Perhaps the biggest difference between the two jurisdictions is accelerated depreciation available in the U.S. which would allow 100% expensing for qualified investments in new or uses tangible property.   If bonus depreciation is used in the U.S., Canco needs to be mindful of the disparity this might create between U.S. and Canadian calculations of taxable income. Other disparities between the two jurisdictions that should be considered are IRC section 1031   exchanges, outside basis adjustment for partnership liabilities   and tax-deferred IRC section 351  rollovers. 6.  Timing of Income Inclusion   We are assuming that USco will be a wholly-owned subsidiary of the Canco with the result that it will be a controlled foreign affiliate of the Canco. Where the business is carried on by USco, consideration will have to be given to whether Canco will not be subject to tax those earnings before the funds are repatriated to Canada. Depending on the source of income, it is possible that there will be no additional Canadian tax payable. For example, if USco carries on an active business, its profit from that business as well as investment income that is incidental to that business as well as gains on the disposition of assets used in the business will be subject to tax in the U.S. and not in Canada. The profit will be included in exempt surplus with the result that it will not be subject to tax in Canada when it is repatriated to Canada in the form of a dividend.  If, however, USco earns passive income, foreign accrual property income or FAPI, that income will be included in Canco’s income on a current basis.   A deduction would generally be available for foreign accrual tax. Should loans be denominated in Canadian dollars or U.S. dollars? If Canco loans USco in U.S. dollars, it will be susceptible to foreign exchange gain or loss in Canada on repayment of principal. Conversely, if Canco makes a loan to USco in Canadian dollars, USco will be subject to foreign exchange gain or loss in the U.S. Given the reduction in U.S. federal corporate tax rates and depending on the applicable corporate tax rate in Canada, Canco may be indifferent to where it recognizes foreign exchange gain.   Conclusion   There are a myriad of Canadian and US tax compliance issues for Canadian businesses expanding into the US A review of at least the items identified in this paper will assist businesses to identify the requirements and to make a calendar of important filing dates. Planning ahead will ensure that proper business structures have been considered, and that all required compliance filings are made to avoid unnecessary and expensive penalties. It will also help to plan for tax compliance issues for Canadian employees spending time or transferring to the US.   Nicholas Kilpatrick is a partner with the accounting firm of  Burgess Kilpatrick and specializes in tax structuring and business development for his small and medium business sized clients.  Please visit our website at www.burgesskilpatrick.com or on Facebook at www.facebook.com/Burgess Kilpatrick for more information on our firm.        

      Leading Tax Advice Call Nicholas Kilpatrick 604-612-8620   Growing Canadian businesses searching for new markets are conducting business on a multinational level. The United States, being Canada's largest trading partner is the country many businesses are seeking first to expand to. Since more businesses are expanding into the United States, Revenue Canada and the I.R.S. have increased audit activity of cross-border transactions. In order to ensure that companies are taxed on their cross-border activity there has been a vast increase in the cross-border tax compliance requirements for businesses, and large penalties to ensure compliance with the new and existing rules. It is imperative that businesses are aware of these rules in order to minimize tax costs as well as to maximize profits and cash flows. There are a significant number of new rules that require information disclosure only. This is however, not to be taken lightly, because the penalties attached to non-filing of this information can be as much or more than the tax bills that many companies pay. The second part of this series on doing business in the U.S goes through various methods to undertake business operations in the U.S   Doing Business in the US - Through Permanent Establishment - US Branch US domestic law provides that foreign companies will be subject to tax in the US on income effectively connected with a US trade or business. The Treaty however, in the case of US companies, restricts the imposition of US tax to situations where the Canadian company has a permanent establishment located in the US Therefore, since US federal tax can be exempted if the Canadian company does not have a permanent establishment in the US, it is important to understand what constitutes a permanent establishment and what does not. Taxation in Two Jurisdictions   As a result of expanding its operations to the U.S., Canco will need to consider the fact that it may have a tax liability and/or a compliance obligation in two jurisdictions.  There are 2 ways that Canco can expand into the U.S:

Branch

Separate Legal Entity

[1](i) Branch Canco is subject to tax on its worldwide income.   Thus, if Canco carries on business in the U.S. through a branch, the income of the branch will be included in the income of the Canadian company for Canadian tax purposes. Any losses may be applied to reduce the income of the Canadian company for Canadian tax purposes. Canco should be entitled to a credit for U.S. federal and state taxes that have been paid;  however, Canco will not be entitled to a tax credit in computing its income for B.C. tax purposes. (ii) Separate Legal Entity If the U.S. business is operated by a separate legal entity that is subject to tax in the U.S. (that is, USco), the income will be subject to U.S. federal and potential state income tax. The U.S. federal corporate tax rate is 21% and considering state income tax the combined rate is approximately 26%.   Generally speaking, USco’s income will not be subject to Canadian tax provided that its income is active business income. This will be discussed further below. Profits that are distributed by USco to Canco may be subject to U.S. withholding tax. The tax treatment of such distribution to Canco will depend, among other things, on the nature of the payment and the surplus account from which it is paid. Unless structured properly, there is a risk that the income earned in the U.S. business could be subject to tax in both Canada and the U.S. Suffice it to say that planning the expansion of the business to the U.S. the right way will ensure that there will be no double taxation. (iii) Tax Rates The following table compares the tax consequences of Canco carrying on the U.S. business as a branch or through USco.   USco US Branch U.S. Taxable Income $1,000 $1,000 U.S. Federal Tax (210) (210) U.S. Withholding Tax (40) (40) After U.S. Tax 750 750 Canadian Corporate Tax 0  (270) Foreign Tax Credit 0 250 After Canadian Corporate Tax 750 730 Canadian Personal Tax (31.43%) (236) (229) After-Tax Cash $ 514 $ 501 [1] Expanding to the U.S the Right Way – Know Before You Go, Canadian Tax Foundation, Catherine A. Brayley, Sidartha Rao   Act Now To Get Our Value Pricing Adjustment on Audit and Review Engagements For Your Business   Similar results between a U.S. Branch and U.S. subsidiary are to be expected. By implementing a U.S. Branch Profits Tax, the U.S. is attempting to put a U.S. branch of a Canadian corporation on equal footing with a U.S. subsidiary of a Canadian corporation. There are a couple of points to keep in mind. If Canco is otherwise eligible for the small business deduction or the manufacturing the processing tax credit, the profits from the U.S. branch will not be eligible for either with the result that the income will be subject to tax at the highest marginal rate. In addition, not all taxes paid in the U.S. may be eligible for a foreign tax credit. For example, if Canco is carrying on business in Canada and does not have a permanent establishment in the U.S., it may still be subject to state income tax because its sales exceed certain nexus thresholds but may not be eligible to claim foreign tax credits for those state income taxes.  Moreover, as will be discussed later, if Canco fails to charge state sales tax and is ultimately liable for the tax it should have collected, it may not be able to deduct that tax for Canadian income tax purposes.  

Treaty

As noted, upon expanding the business to the U.S., Canco will have to deal with the U.S. tax implications of the arrangement in addition to the Canadian tax consequences. The Treaty can provide some relief to Canco from being subject to tax in the U.S. To benefit from the Treaty, an entity must be fully liable to tax. As will be discussed if the entity is a “C” Corporation, its income will be subject to tax in the U.S. In the case of a “C” Corporation, the Treaty provides that where a company is considered to be a resident of Canada and a resident of the U.S., it is treated as a resident of the U.S. based on its place of incorporation.   In the case of a Limited Liability Corporation, as will be discussed, the LLC is fiscally transparent and its members are subject to tax on the profits of the LLC for U.S. tax purposes. Thus, if the LLC is resident in Canada because its central management and control is exercised in Canada, there is a potential for double taxation. In this situation, it would be critical that the central management and control of that entity be exercised in the U.S. Under the Treaty, a resident of Canada will be subject to tax in the U.S. on business profits only if a business is carried on in the U.S. through a “permanent establishment.”  If Canco is found to have a permanent establishment in the U.S., the U.S. will have the right to tax the business profits that are attributable to that permanent establishment.As only the profits that are attributable to that permanent establishment will be subject to tax in the U.S., it will be important to determine the amount of the profits that are attributable to the permanent establishment. The methodology for determining the profits should be documented. What is a permanent establishment? The Treaty defines permanent establishment to mean a fixed place of business through which the business of a resident of one country is wholly or partly carried on. 24  It is also defined to include a place of management, a branch, an office, a factory, a workshop and a mine, oil or gas well, a quarry or any other place of extraction of natural resources. Having a fixed place of business is somewhat obvious. The Treaty addresses more than that. A permanent establishment can arise where there is an ability to conclude contracts in its name. The conclusion of contracts   and the provision of services by persons in the U.S.  could also result in a permanent establishment. If Canco would not otherwise have a permanent establishment but provides services in the U.S., Canco could be deemed to have a permanent establishment if the services are performed by an individual who is present in the state for a period or periods exceeding 183 days  or more in any 12-month period, and, during that period, more than 50% of the gross active business revenues consist of income derived from services performed by that individual.  A permanent establishment can also be deemed to arise if the services are provided for 183 days or more in any 12-month period for the same or connected project for customers who are either residents or have a permanent establishment in that state. It will be very important for Canco to determine the number of days that it will be required to have someone present in the U.S. and the percentage of the U.S.-source revenues to all of its revenues. Canco will also have to maintain records, together with support, confirming the number of days spent in the U.S. by each individual.  The requirement is not on an annual basis but rather a 12-month basis. On the other hand, the use of facilities for the purpose of the storage, display or delivery of goods will not constitute a permanent establishment.  Nor will the maintenance of a stock of goods for the purpose of storage, display, delivery or processing   or the purchase goods or the collection of information.  Finally, advertising, the supply of information, scientific research or similar activities that have a preparatory or auxiliary charter for the resident will also not result in a permanent establishment. It will be important for Canco to consider carefully how it will have to execute on its desire to expand to the U.S. to determine if it has a permanent establishment or not. If Canco determines that it will not have a permanent establishment, it will still have to consider whether there is a U.S. compliance obligation. If Canco lacks a permanent establishment but has income effectively connected to a U.S. trade or business or is otherwise engaged in a U.S. trade or business, it must affirmatively file what is known as a “Treaty-Protective tax return.”  This tax return declares to the Internal Revenue Service that the corporation is engaged in business activity in the U.S. but includes a treaty position declaration that it is protected from U.S. federal income tax pursuant to the terms of the Treaty.   Conclusion   There are a myriad of Canadian and US tax compliance issues for Canadian businesses expanding into the US A review of at least the items identified in this paper will assist businesses to identify the requirements and to make a calendar of important filing dates. Planning ahead will ensure that proper business structures have been considered, and that all required compliance filings are made to avoid unnecessary and expensive penalties. It will also help to plan for tax compliance issues for Canadian employees spending time or transferring to the US.   Nicholas Kilpatrick is a partner with the accounting firm of  Burgess Kilpatrick and specializes in tax structuring and business development for his small and medium business sized clients.  Please visit our website at www.burgesskilpatrick.com or on Facebook at www.facebook.com/Burgess Kilpatrick for more information on our firm.        

      Leading Tax Advice Call Nicholas Kilpatrick 604-612-8620   Canadian tax liability generally turns on whether a person is a resident or a non-resident of Canada. A person who is resident in Canada during a tax year is subject to Canadian income tax on his or her worldwide income from all sources, which includes income from an office, employment, property, or business. Accordingly, an individual who is a resident of Canada is subject to Canadian tax on any income earned directly from a source outside Canada. This includes dividends received on shares of non-resident corporations, which would generally be characterized as income from property and included in a taxpayer's income for the year in which the dividends are received (or in which the taxpayer becomes entitled to receive the amount). Subsection 91(1) is an exception to the general rule that income is recognized in the year in which it is received or receivable by a taxpayer. Canadian taxpayers are subject to current taxation on FAPI earned by closely held corporations (CFAs) regardless of whether the FAPI is repatriated to Canada in the year income or profits are realized by the CFA. Specifically, in computing taxable income for a taxation year, taxpayers are required to include their "participating percentage" of the FAPI earned by each of their CFAs pursuant to subsection 91(1). The amount corresponding to the taxpayer's FAPI inclusion for the year is added to the adjusted cost base (ACB) of its shares in the CFA. Subsection 91(1) characterizes the inclusion of FAPI as "income from a share," meaning that FAPI is considered to be income from property under the Act. As a result, FAPI included in the income of a CCPC is Aggregate Investment Income (AII). AII earned by a CCPC is subject to a refundable tax on investment income, which results in AII being taxed at an initial rate of 48.7 percent to 54.7 percent. The additional investment tax is refunded to a corporation when it pays out sufficient dividends. When combined with the general corporate income tax rate, the refundable tax on AII results in an initial corporate rate of tax roughly equivalent to the top marginal rate for individuals, thereby denying individual taxpayers any deferral advantage from earning investment income through a corporation[1]. ITA provides specific definitions of types of income Passive income for the purpose of FAPI. Nonresident corporations are generally referred to as foreign affiliates, and there are rules when a corporation is a foreign affiliate or a controlled foreign affiliate of a Canadian resident taxpayer. [1] Corporate Integration: Outbound Structuring in the United States After Tax Reform, Kevin Duxbury and Tim Barrett. Quick Facts About FAPI   The actual purpose of FAPI is to avoid a tax deferral by Canadian tax residents, potentially indefinite on most foreign passive investments. Before we go to the overview of different income types included in FAPI, let’s have some quick facts:

• FAPI is included in the income of the Canadian shareholder when earned by its Controlled Foreign Affiliate (CFA) not when distributed. It’s on a current and accrual basis and included based on a term specifically defined as a participating percentage. 
• Foreign taxes do not provide a direct foreign tax deduction or credit, instead, an income deduction is available for a term defined as Foreign Accrual Taxtimes relevant factor. See further below.
• Active business income may be recharacterized as FAPI in certain cases and vice versa.
• It is calculated on an affiliate-by-affiliate basis in a way that it cannot be a negative number.
• Net losses from CFA  cannot be used to offset income from other sources of a Canadian corporation or the FAPI from another CFA. However, FAPI can offset a corporation’s non-capital losses from other sources.
• If the income inclusion under FAPI is less than $5,000, it does not need to be included in the income of its shareholder.
• FAPI is calculated using the Canadian income tax rules in Canadian dollars.
• FAPI affects the ACB of shareholders in the shares of CFA and negative ACB can trigger capital gains in Canada.
• Repatriation of the income already taxed as FAPI is not taxed again in Canada.

  6-Step Approach To FAPI Determination   Adopting the below systematic approach may help in determining the FAPI and its tax effects on the Canadian taxpayer:

Identify foreign affiliates and determine if there are any Controlled Foreign Affiliates.

Calculate the FAPI as per subsection 95(1) of ITA.

Determine the participating percentage of the Canadian shareholder as per subsection 95(1), and include in the income of Canadian shareholder’s income as per subsection 91(1).

Determine the Foreign taxes already paid by the CFA and calculate the deduction allowed as per subsection 91(4).

Calculate Canadian income tax on FAPI

Calculate the Adjusted cost basis for the shares of the CFA. If any negative ACB, determine if it triggers capital gains.

Controlled Foreign Affiliate A Canadian shareholder of a foreign affiliate (FA) includes FAPI in its income only if it is a Controlled Foreign Affiliate (CFA). A CFA is always a FA, however, FA does not have to be a CFA. Therefore, the first step is to determine whether the foreign affiliate is a CFA or not. Generally, a foreign affiliate is a CFA if the Canadian shareholder owns more than 50% of the shares. De Jure Control is an ability to elect members of the board of directors and can exist even if the equity percentage is less than 50%. Subdivision i of ITA provides the definition of FA and CFA. The definition seems to be straightforward but it may not be the case always. Subsection 95(1) also provides that if the Canadian shareholder and a specified number of other Canadian shareholders in aggregate control the foreign affiliate, it is a Controlled Foreign Affiliate of the taxpayer!   Act Now To Get Our Value Pricing Adjustment on Audit and Review Engagements For Your Business   Income from property  Generally, income from the property is passive income such as rent, royalties, dividends, and royalties.

• ITA 95(1) specifically includes “Income from an investment business”. It also provides the definition of investment business and related exceptions. Again, in general, income is from rents, royalties, interest and dividends.

Income from Non-Qualifying Business   Canada has tax treaties with the majority of countries across the world. Canada discourages business with countries that do not have a tax treaty with it or have not signed a tax information exchange agreement (TIEA). Active income from business in such a Non-Designated Treaty Country (Non-DTC) is FAPI. Income from an Active Business    Income from an active business from a Designated Treaty Country (DTC) in most cases is not FAPI. There are situations where this active income might be recharacterized as FAPI or situations where foreign-affiliated dumping rules apply. Similarly, there are certain situations where income from the property might be recharacterized as active business income. Excluded Property  As mentioned in the definition of FAPI, taxable capital gains from the disposition of property add to FAPI unless they are from Excluded Property.  If the property used in the active business of a foreign affiliate is very closely related to running an active business, the gains from the disposition of such properties do not give rise to FAPI inclusion. Investment Property An investment property is not an excluded property. Gains on the disposition of an investment property are included in FAPI. Investment property includes shares, partnership interests, trust interests, annuities, indebtedness real property or immovable property, resource properties, interests in funds and entities, and interests or options in any of the above. Participating Percentage  FAPI is calculated on a share-by-share basis and the participating percentage is the share of this income established for Canadian shareholders of CFA. Subsection 95(4) defines and modifies the definition of participating percentage so that only the lowest tier Canadian shareholder includes FAPI in its income. This is important in situations with multi-tier corporate structures. Depending on equity share in different classes of shares, if the FAPI of the controlled foreign affiliate is $5,000 or less, the participation percentage is zero. Note that this ($5,000 threshold) is the FAPI of the CFA, not the FAPI of its shareholders. The product of the participating percentage and per share FAPI of the CFA is added to the income of the Canadian shareholder.   FAPI is calculated on the last date of the fiscal year end of a CFA and added to the shareholder’s income on that date. There are provisions for short year ends and other reorganizational changes during the year.  FAPI is normally calculated in Canadian dollars.  Income Deduction based on Foreign Accrual Taxes (FAT) The foreign taxes paid or accrued by a CFA do not give rise to an equivalent deduction from the income or income tax in Canada as one may think. The deduction is instead allowed from the income included as FAPI under subsection 91(4) equivalent to the product of Foreign Accrual Tax (FTA) and a Relevant Tax Factor (RTF). The purpose of FAPI inclusion is to deter Canadian shareholders of foreign corporations (base companies) to get tax deferral advantage while earning FAPI-styled passive income. In the absence of these base companies, Canadian taxpayers must include such an income on an accrual and current basis. The underlying concept is to allow a deduction equivalent to what would have been Canadian income if the same amount of taxes were paid in Canada. Foreign Accrual Tax includes income tax paid by CFA on the income included in FAPI, FAPI of another fiscally transparent FA, or withholding taxes paid on receiving dividends from other FAs if they are part of the FAPI inclusion. The amount of deduction from FAPI included in shareholder income is equal to FAT x relevant tax factor (RTF). The deduction is not available to finance the higher taxes in foreign jurisdictions, therefore, there is a limit imposed on this deduction that it cannot be more than the FAPI inclusion. The taxes must be paid in order to claim this deduction. Adjusted Cost Base of Shares  The final step is to calculate the Adjusted Cost Base (ACB) of the shares of the CFA. The income included under 91(1) is added to ACB and the amount deducted under 91(4) is subtracted from the ACB of the share of the CFA that the Canadian taxpayer holds. The FAPI calculation is never a negative number. In case of negative ACB of the shares, a Capital gain is triggered. Subsections 93(1) and 92(1) further provide mechanisms to avoid double taxes on capital gains. Example   Two Canadian resident individuals own a Canadian corporation (CanCo) that owns U.S. treasury bills in a fully owned U.S. Corporation (USCO) – 100 shares. Step 1: Since the ownership of USCO is with CanCo and not the individuals, FAPI analysis and income inclusion need to be done for CanCo. USCO is a CFA of CanCo. Step 2: Assume this corporation earned interest on T-bills worth $10,000 during its fiscal year. Step 3: Participating percentage per share is 100%.  Therefore per share, the FAPI of CFA is $100 Step 4: Calculating income inclusion and deduction. Assume $2,000 taxes already paid in the U.S. by CFA. [Participating percentage x FAPI per share is $100] x 100 shares = $10,000 income as per 91(1) [1/(38%-13%) x taxes paid of $2,000] = [4 x 2,000] = $8,000 deduction as per (91(4) Step 5: The net amount added to the Canadian tax base is $2,000. After applying a tax rate of 25%, CanCo pays $500 tax in Canada. The total tax paid now is 2,000 in U.S. and 500 in Canada with a total of $2,500. Step 6: Add $10,000 to the ACB of shares and deduct $8,000 from the ACB. [2] [2] “Foreign Accrual Property Income”, Maroof Hussain Sabri Nicholas Kilpatrick is a partner with the accounting firm of  Burgess Kilpatrick and specializes in tax structuring and business development for his small and medium business sized clients.  Please visit our website at www.burgesskilpatrick.com or on Facebook at www.facebook.com/Burgess Kilpatrick for more information on our firm.        

      Leading Tax Advice Call Nicholas Kilpatrick 604-612-8620   FOREIGN AFFILIATE ISSUES 1. UNDERSTANDING THE CALCULATION OF FAPI 2. CROSS BORDER STRUCTURE TO REDUCE COMBINED TAX   Canada and the US are each other’s largest trading partner, and many Canadian corporations have extended their domestic operations to the US in hopes of securing market share for the products and/or services they provide. Similarly, US corporations have ventured into the Canadian market to likewise grow their own brands. Both jurisdictions provide options regarding the structures within which these business interests are held; however, the tax and filing consequences arising from these various structures can vary.  In order to structure cross-border activities in a manner that minimizes tax exposure and sufficiently protects assets, the various possibilities available to structure such activities must be considered to make sure that businesses on both sides of the border are able to operate effectively. In addition, care must be taken to confidently understand the tax treatment of income travelling across the Canada - US border. This article deals primarily with Outbound investment by a Canadian corporation with a US subsidiary.  A future article will deal with relevant Inbound structures and issues from a Canadian perspective. FAPI   Canadian corporations owning controlling interests in corporations operating in foreign jurisdictions – termed controlled foreign affiliates (CFA’s) - have a substantial reporting and administrative responsibility to ensure that they stay compliant with the Canada Revenue Agency’s (CRA) disclosure requirements regarding transaction activity with and interests in those respective foreign entities. While the repatriation of income from a CFA engaged in an active business[1] can be carried out without any additional tax applied at the corporate level, the mechanism behind the repatriation of income and capital when the CFA  is not an active business, and the tax consequences thereof, is much more complicated. Income from a CFA that is not considered for Income Tax Act (“ITA”) purposes to be active business income is defined as Foreign Accrual Property Income - or FAPI, and includes, but is not limited to, such non-active business income as interest, dividends and rent.  The department of Finance’s intention behind the FAPI scheme is, in part, to prevent the permanent deferral of Canadian corporate-level taxation on income earned by a parent Canadian corporation (also called a corporation resident in Canada, or CRIC) through a CFA. For example, consider the following scenario:

A CRIC owns 100% of the outstanding shares of a CFA;

The CFA is domiciled in a jurisdiction with which Canada has entered into a Tax Treaty or a Tax Information Exchange Agreement (TIEA);

The CFA earns net income of $10,000 that does not fit the definition of Active Business Income (ABI) as defined in the ITA.

The tax rate of the CFA is 25%, resulting in retained earnings remaining in the CFA - which can be repatriated back to the CRIC - of $7,500.

  Simplifying the scenario by assuming that there are no material differences in the computation of taxable income between Canada and the CFA, and that there are no foreign exchange differences, without the FAPI tax regime in place, the CRIC would be able to defer $7,500 in income subject to Canadian taxation by leaving it in the CFA’s bank account indefinitely.   The FAPI regime exists to tax FAPI income on a current basis, meaning that applicable Canadian tax must be paid on the FAPI income whether or not the income is repatriated back to Canada.   Subsection 91(1) characterizes the inclusion of FAPI as “income from a share”, meaning that FAPI is considered to be income from property under the Income Tax Act.  As a result, FAPI included in the income of a Canadian-Controlled Private Corporation (CCPC) is also considered to be Aggregate Investment Income (AII)[2].  AII earned by a CCPC is subject to the refundable dividend tax on hand (RDTOH) regime, which results in AII being taxed at between 48.50% to 53.5%, depending on which province in Canada the CRIC has its management.   Proposed rules to effectively decrease the tax deduction under subsection 91(4) for the foreign tax paid by the CFA will increase the amount of income subject to tax by the CRIC, and, because that income is subject to the Non-eligible / Eligible Refundable Dividend Tax On Hand (RDTOH) tax regime (assuming the CRIC is a CCPC), will effectively increase the amount of tax paid by the CRIC on FAPI income earned by the foreign affiliate. This is because the tax deduction calculated under subsection 91(4) is based on a Relevant Tax Factor[3]. The Relevant Tax is a multiplier that, when multiplied by the Canadian equivalent of the foreign tax paid (also called Foreign Accrual Tax, or FAT), seeks to simulate the Canadian corporate tax that would be paid had the income been earned in Canada.   The Department of Finance, in its 2022 Budget, has proposed to reduce the Relevant Tax Factor applicable in the calculation of the tax deduction available from 4 to 1.9 to simulate the tax deduction available to Canadian individuals investing in a CFA directly.  This is reflected in the “Proposed” column on the chart below. [1] The term “Active Business” is defined in Income Tax Act (“I.T.A”) subsection 125(7) as “any business carried on…and includes an adventure or concern in the nature of trade”. [2] Defined in ITA subsection 129(4) [3] Defined in ITA subsection 95(1) With the current FAPI regime, tax on the CFA’s income of $10,000 is calculated as follows:     The ending combined tax rate of 51.60% in the proposed column is marginally higher than the investment income rate of 50.67% payable by a CCPC resident in B.C on passive investment income, proving that, despite the reduction in the Relevant Tax Factor proposed, full integration is not yet achieved, at least not yet in B.C.   The main purpose behind the reduction in the tax deduction under 91(4) is to replicate, as closely as possible, the combined Canadian and foreign tax consequences to an individual of earning FAPI income. In effect, the Department of Finance has taken away the deferral advantage of holding FAPI income in a CCPC. The amount of net income earned from the CFA, less the combined tax paid, is added to the cost basis (ACB) of the shares held by the CRIC in the CFA, and is also added to the taxable surplus balance of the CFA that the CRIC must track.  This amount of net income less combined tax can be repatriated to the CRIC without additional tax consequences. Specifically, dividends paid to the CRIC out of the CFA’s taxable surplus balance will reduce the taxable surplus balance of the CFA, and are deducted on the CRIC’s tax return in the year in which the dividend was received under subsection 113(1)(b) and under subsection 91(5) to avoid tax payable on the repatriated dividend.  In addition, the ACB of the CRIC’s shares in the CFA is reduced by an amount equal to the repatriated dividend received.  Amounts deductible by the CCPC under section 113 are also added to its General Rate Income Pool  (GRIP)[4]; the shareholder(s) is entitled to an eligible dividend equal to the amount repatriated from the CFA. Using Canadian corporate funds to make an investment in a foreign affiliate earning FAPI, however, is the better tax option over investing directly in a US rental property from a CCPC if there is income subject to foreign tax. Although application of FAPI tax treatment on the income earned by the CRIC is not contingent on whether or not there is a tax treaty or TIEA between the CRIC and the CFA, such an agreement will normally reduce the applicable tax rate on non-active business income repatriated from the CFA and, combined with the calculation of the applicable tax credit the CRIC will receive under ITA subsection 91(4), may result in a refund of foreign tax, depending on the amount of foreign tax paid when earned by the CFA. Using Canadian corporate funds to make an investment in a foreign affiliate earning FAPI, however, is the better tax option over investing directly in a US rental property from a CCPC if there is income subject to foreign tax. Although application of FAPI tax treatment on the income earned by the CRIC is not contingent on whether or not there is a tax treaty or TIEA between the CRIC and the CFA, such an agreement will normally reduce the applicable tax rate on non-active business income repatriated from the CFA and, combined with the calculation of the applicable tax credit the CRIC will receive under ITA subsection 91(4), may result in a refund of foreign tax, depending on the amount of foreign tax paid when earned by the CFA.   [4] GRIP is defined in subsection 89(1).  Pursuant to paragraph (b) of element E of the definition, amounts deductible under section 113 in computing income of the corporation for a particular year are added to the corporation’s GRIP balance.       Act Now To Get Our Value Pricing Adjustment on Audit and Review Engagements For Your Business   COMMON COMBINED CANADA-US CROSS-BORDER STRUCTURE When a Canadian corporation, or CRIC, decides to invest in a business in a foreign jurisdiction, it does so for various reasons, such as a desire to control a potential return on capital invested greater than that which can be controlled in Canada. There may be bona fide reasons to invest in a jurisdiction with which Canada has a tax treaty or TIEA, and which jurisdiction has a lower tax rate on business income than in Canada, or there may be labour or other resource advantages in the foreign jurisdiction that, when incorporated into a feasibility analysis, renders the return on investment in the foreign jurisdiction palatable to stakeholders of the Canadian parent corporation. If the decision is made to invest, or start-up, a foreign affiliate, thought and activity focuses on how to set up the ownership structure of the foreign affiliate to facilitate (a) the ability to extract as much capital as possible on a tax-free basis from the foreign affiliate, (b) to hopefully minimize - or organize - to the extent possible filing and reporting responsibilities, and (c) to enable the extraction of equity without onerous tax and/or administrative consequences. There are various outbound structures available when a CRIC invests in a foreign affiliate, depending on the characteristics that stakeholders in the Canadian corporation seek to prioritize in the structure.  A common structure to facilitate cross-border activity and that aims to provide:

Liability protection

Efficient tax administration

  is as follows:   In this example, we assume that the Canadian corporation will be investing in a foreign affiliate in the US and will own 100%of the outstanding shares, so the LLC will be a CFA of the Canadian corporation. Unless an LLC elects to be treated as a corporation and to be taxed as such (IRS form 8332), a single-member LLC is disregarded as an entity separate from its member.  This means that the member will report the income from the LLC on his/her US personal tax return. By contrast Canada views LLC’s as corporations, so if you have a Canadian corporation and a US entity that elects to be taxed as a corporation, you will have a combined structure that can access available tax credits and deductions available for cross-border income scenarios.[5]  If the LLC does not elect to be taxed as a corporation, relief in Canada on foreign taxes paid is available under 126(1) and 20(11), because income generated by an LLC considered a disregarded entity is characterized as income from a share, and the tax paid is characterized as “non-business income tax”. When the Canadian corporation reports the LLC income, depending on how the LLC has been designated, any dividends paid from the Canadian corporation to the individual sourced from the LLC will be entitled to a deduction under ss.113(1)(c) if the LLC is considered a disregarded entity, and under ss.113(1)(b) if the LLC is considered a corporation. As you can see, there are mechanisms in place to provide integration of tax between Canada and, in this case, US business interests.  However, integration is not complete, and a careful study of proposed combined corporate structures should be undertaken to accurately assess tax treatment.   Nicholas Kilpatrick is a partner at the accounting firm of Burgess Kilpatrick in Vancouver, B.C.  He specializes in cross-border taxation and assisting clients in acquisition structures.  Check us out at: https://www.burgesskilpatrick.com [5] CRIC income from an LLC that has elected as a corporation will have access to a foreign tax credit based on “business and profits tax” paid in a foreign country under ss.126(2). If the LLC is considered a disregarded entity, relief is available under ss. 126(1) and ss.20(11)to account for foreign taxes paid.    

Leading Tax Advice Call Nicholas Kilpatrick 604-612-8620 If you’re a leader, you want to show up for your people in a way that makes them feel excited to be at work, makes them think they can trust you as a leader, allows them to trust each other as a team, and contribute meaningfully to the team and the organization. Meetings are a great way to set the right cultural messages to your teams! Believe it or not, how you show up in a meeting can fairly quickly make people feel more trusted and empowered! To elevate your presence as a leader, try out these tips in your next meeting: 1. Be clear about why your team feels they need you there Often, especially in businesses where the culture orbits around a well-observed hierarchy, team members tend to feel less autonomous and therefore feel the need to get permission or validation from their leaders. If this is why they are inviting you to the meeting, you should decline and let them know that you empower them to make the required decisions. 2. Do not pay attention to your phone or any other device Make sure that your team has your undivided attention. By doing this, you are showing respect and consideration to your team. 3. Practice listening far more than you’re speaking Try this: put a metric in your mind around 80-20 or even 90-10, where you are listening about 80 or 90% of the time and speaking the balance. 4. Watch your language When you ask questions, avoid using long, flowery “impressive,” “look how smart I am” language. Keep your language very simple and relatable. Speak slowly and clearly. 5. If the group goes off-topic, pull them back However, do this is by asking a question. Try asking the group: “Hey, is there a connection between what we’re talking about now and what we started talking about? I don’t see the connection, so can you guys let me know why we’re talking about this? What am I missing?”     Premium Accounting and Tax Assistance - call Nicholas Kilpatrick at 604-327-9234 to find out more for your business and click here to see our latest first-time offers.   6. Ask for advice Once you get to the point of the meeting where people are starting to either talk about ideas or next steps, inevitably, at some point, all eyeballs might turn to you. Here’s what I recommend at that point. Before you share any of your ideas, Turn it back onto everyone else in the group and ask for their thoughts. Once they start to share their opinions, if it is different from what you probably had in your mind, again, continue with the line of questioning and say something like: “tell me more about that.” 7. Draw out all opinions in the room Scope around and ask for the views of the quieter individuals. By doing this, you’re going to ensure a clear consensus across the team on the next steps. You are getting the more quiet individuals comfortable speaking. You are helping to re-balance the social dynamic across the team and making it very clear that every opinion matters. 8. End strong I strongly recommend that you cap the meeting off with a statement like: Thank you for inviting me to this meeting, I enjoyed participating in this session”. Nicholas Kilpatrick is a partner at the accounting firm of Burgess Kilpatrick  in Vancouver, B.C.  He concentrates his practice on assisting business owners with accounting services, tax and estate planning and overall business development. This article was sourced from Real Leaders

Leading Tax Advice Call Nicholas Kilpatrick 604-612-8620   Time management is perhaps one of the most researched, studied, and obsessed over concepts in all of management. Back when physical bookstores were more relevant, you could find entire sections devoted to time management. People travel the world to attend seminars with time management gurus. If you’re an aspiring or practicing manager, consultant, or business owner, you’ve probably encountered some of this already. The business world does, to some extent, self-select for people who take a proactive role in their own time management. You might even be naturally good at time management, at least on a personal level. Maybe you realized you could save the time you’d spend cooking every day by doing one day of meal prep per week. Maybe you’ve mastered the art of squeezing in a workout while listening to an audiobook in-between appointments. It’s certainly an advantage for a manager to be skilled at time management. But practicing effective time management for an entire workforce is a whole other ballgame. You already know how much discipline, self-knowledge, and forethought goes into effective time management on an individual level. When you add a second person to the mix, a new kind of collaborative system is created, and the complexity is essentially squared (see: marriage, or any kind of human relationship). Every new individual or procedure you add to a team or system has the potential to increase the complexity exponentially. Getting Teams Firing On All Cylinders If you’ve ever overseen a project or team, you know that any collaborative achievement, no matter how small, is something of a miracle. Bodies, resources, and procedures of all kinds must be synchronized. If they’re not, the project is vulnerable to confusion, mistakes, conflict, and other obstacles detrimental to the fulfillment of the shared goal. Almost everyone has had the experience of trying to ride a bicycle with a chain that has come loose. Even the slightest misalignment of an intricate system can render it useless.
Time Management Definition. Before we go any further, it’s worth taking a step back and asking the rather obvious question: what is time management? First, we’ll establish a clear time management definition. This will ensure we’re on the same page before we move on to the many benefits of time management. For the purposes of this article, when we refer to time management, we mean the strategic use of an individual or organization’s time toward the fulfillment of the individual’s or the organization’s goals. Time Management Skills Of course, effective time management doesn’t just happen. Good time management is made of many smaller time management skills, used in tandem with one another. Here are a few key skills you’ll need to manage time effectively. 1. Prioritization Time management is all about being strategic with your use of time to maximize the likelihood of fulfilling your goals. Of course, our larger and long-term goals are often made of short-term objectives and needs. Powerful managers of time will recognize which objectives are upstream of others, and work to fulfill them in an appropriate order.     Get Access to leading accounting and tax help. The time is now to get the right help and not waste any more effort getting mediocre results - call Nicholas Kilpatrick at 604-327-9234.   2. Vision and Goal Setting Prioritization only works properly if the goals are clearly defined and communicated. There must be a balance between overarching, long-term goals and shorter-term goals. 3. Lists To-do lists enable prioritization. They force you to get things out of your head and down on paper. When you have extra time and are trying to figure out to do with it, your to-do list system can be referenced. This can help you fill the time you have as productively as possible. Getting Things Done, by David Allen, is one of the most successfully and popular books about productivity of all time. In this book, Allen stresses how long term, medium term, short term, and daily to-do lists can be integrated into a system to help you better manage your time. 4. Delegation Teams are made of multiple people for a reason. Large projects require more energy, skills, and knowledge than any individual possesses. Good time managers make use of their team by delegating responsibilities for optimal results. You should not be working on something that someone else can do faster or at a far lower cost. 5. Systems Thinking Workforces, operational processes, supply chains, markets, and timetables are all systems with many interlocking and moveable parts. People good at managing time often have experience overseeing the operation of complex and interdependent systems. 6. Ability to Concentrate It is natural for the mind to wander. And sometimes, this can lead to creativity. But it’s difficult to be an effective manager of your own time if you are easily distracted from what you need to focus on. Time Management Tips In addition to the time management skills listed above, there are some more practical time management tips and time management strategies we’ve collected here. Our first 3 time management tips are somewhat high level and strategic in nature. 1. Let Go of What You Don’t Need This is probably the most important aspect of time management. Nobody gets into business – or at least nobody stays in business – unless they have some combination of stubbornness, ambition, and optimism. You might call this combination of qualities bull-headedness. Bull-headedness can be an extremely powerful quality in some situations, but it can be harmful when it comes to time management. It’s easy to get hung up on trying to fight yesterday’s battle, or to keep pursuing an old goal at all costs. Many managers have found wisdom in an old gambler’s expression: don’t throw good money after bad. That wisdom can be applied to time management. Don’t waste time chasing something unnecessary. 2. Be Strategic With the Things You Really Do Need In addition to shedding old goals and processes, you’ll need to learn to properly sort out the needs that remain. Let’s say your team is responsible for overseeing the renovation of a building. It’s true that you will eventually need to choose a paint color, but before that you’ll need to make sure the walls are structurally sound, the electricity/plumbing operational, etc. It wouldn’t make sense to have all your workers prioritize sorting through paint samples before taking care of the other stuff. 3. Don’t Forget What It Means To Be Human One thing we often see is people neglecting to schedule self-care. This might come in the form of socializing, exercising, experiencing nature, eating, etc. If we don’t get our physical/psychological needs met, we run the risk of burning out. It’s also true that, on an organizational level, managers sometimes emphasize the needs of the company without considering the needs of the human beings that make up the company. The resiliency of our organizations, and the efficacy of everything we do, will both be improved if we remember to provide sufficient care on a human level. Now, let’s explore a few more tactical time management tips. 4. Embrace Technology There are note taking and calendar apps that can and should be used to manage your time more effectively. From OneNote to Evernote to something as simple as Google Calendar, there are many time management apps and time management tools to help you be more productive. 5. Manage Your Calendar Use your calendar to block off personal time. Use it to block off creative time. Use it to force yourself to spend time on longer term, strategic projects that you might otherwise ignore until it becomes too late. 6. Plan Out Your Calendar in 15 or 30 Minute Intervals Have you ever had so much to do that you just didn’t know where to start and eventually waste hours in a state of limbo accomplishing much less than you thought you would? We surely have.
When you organize your tasks for the day and week in 15 to 30 minute intervals and put them on your calendar, it helps you mentally commit to working on those tasks. The shorter chunks of time also make the tasks not as intimidating. Placing these soft internal deadlines on yourself will also help you see how much time you should budget for each assignment and help organize your day. We also suggest organizing your tasks in order of priority so you get the important things out of the way first.
Of course, there will be times when you can’t complete tasks in time, but you can always re-budget your time and move things around in your calendar as needed. The important thing is to commit to them on a calendar and getting to work. 7. Create the Right Working Environment and FOCUS! This time management and productivity technique is crucial and easy. We know it’s tempting to check your phone and see that cat meme your friend tagged you in on Instagram. We know and feel your pain.
It may not seem like a big deal, but each small distraction greatly lowers productivity as a whole.
To focus well, you need to create the right environment by putting away any potential distractions. This includes turning your phone off (yes, OFF!), putting food at a distance where you can’t see it, and placing blocks on your calendar so your co-workers know not to interrupt you.
This isn’t a new or novel time management and productivity technique but it is an extremely important one that should not be overlooked. 8. Set Expectations so You Know When You Are Done Perfection is would be great to achieve consistently – but we must recognize that more often than not, perfection is an ideal, not a necessity. Setting high but reasonable expectations with each task is important in boosting your productivity.
An author could write and revise a book endlessly but at some point, she needs to put down her pen and publish. The same goes for work.
While spending extra hours on certain things is necessary, spend too much extra time on every assignment is a productivity killer. Understand expectations from your seniors and do the best you can with the limited time you have. Do jobs well, not perfectly. 9. Manage Your Energy Rather Than Your Time There are certain times in the day that are better for certain tasks. For example, if you’re a morning person who thrives with creativity energy from 6AM-10AM, then block that time out for brainstorming and strategizing. You don’t want to be wasting that time in meetings or answering emails.
Everyone is different, but if you are a manager at a firm, make sure to speak with your employees. Learn what their best habits are and do your best to accommodate to their periods of productivity. It may make team schedules a little less flexible, but it will likely lead to a boost in productivity. 10. Take Smart Breaks It may sound counterintuitive, but taking breaks in a strategic way is actually a very important way to increase productivity. If you feel burnt out, there is no way for work to be done in an effective manner. We recommend taking breaks after a certain interval (i.e. 30 minutes) or after a significant task is accomplished.
Additionally, make sure you are taking small breaks that won’t lead to longer ones. For example, you may want to take a short walk around the office rather than \ browsing through YouTube and risk getting sucked into a black hole of recommended videos. Time Management Examples In order to really appreciate the importance of time management, let’s look at some time management examples. Let’s say your goal is to get into an MBA program so you can pursue a career as a management consultant. You have three months until you take the GMAT. That seems like a lot of time. You go into it feeling good about your ability to prepare for the test. However, you fail to schedule in any specific time to do your test prep. You let it slip your mind for several weeks until finally you only have a few more weeks to prepare. But those last weeks are busy, and things keep going wrong. You end up hardly studying at all. What happened? You failed to practice effective time management.
Other examples of bad time management: you pay your employees to sit and do nothing as they wait for a component to be delivered. Your information flow is inefficient and small amounts of regularly wasted time gradually add up. Or you fail to establish a regular procedure for a frequent problem or need. All these examples of bad time management lead to wasted time, and wasted dollars. How to Manage Time The main focus areas of time management are prioritization, organization, and execution. Prioritization involves defining short and long-term goals so as to define the values by which you manage your time. This is where an app that details what’s actually consuming your time, or a book that helps you map out what’s truly important to you, can come in handy. Organization refers to all the ways you actually strategize how to spend your finite time. This is where a powerful cross platform time-keeping and task-logging app, such as Remember the Milk, can help you. Execution refers to your ability to enact your plans in accordance with the timetables you envisioned.
Finally, it’s important to remember that the goal of time management is to allow for the most effective use of time, energy, and attention. No matter what quadrant the activity you’re doing falls under, bringing real presence to the doing of that activity will go a long way in making the best use of your resources. Time Management Training If you’re the kind of person who learns best from formal teaching, then you’ll be interested in time management training. There are many different individual coaches and large-scale educational organizations devoted to training people in time management, including Management Consulted. Contact us today to see how we can help your organization improve prioritization and time management skills. Conclusion As we have seen, time management is precisely the art of diverting our resources toward those things most important to us. Our time management skills, therefore, are what determine whether our actions add up to our long-term goals, or whether they take us somewhere else entirely.
The world offers an unprecedented array of enemies to our time management skills. But it also offers totally new resources for reclaiming your time and attention. From time management tips, to apps to books to companies that specialize in time management training, there is help available for you if you want it. We suggest taking a close look at how you can improve your own time management skills today. Nicholas Kilpatrick is a partner at the accounting firm of Burgess Kilpatrick  in Vancouver, B.C.  He concentrates his practice on assisting business owners with accounting services, tax and estate planning and overall business development. This article was sourced from managementconsulted.com

Leading Tax Advice Call Nicholas Kilpatrick 604-612-8620   Steve Jobs was wearing jeans and sandals under a black graduation gown as he stepped to the podium to deliver Stanford University’s commencement address in June 2005. It was quite a scene, with some 23,000 faculty members, alumni, newly minted graduates, and their parents jamming the floor and bleachers of the school’s football stadium. After all, who better than this icon of personal technology, the legendary entrepreneur who started up Apple Computer—soon to be the world’s most valuable company—to tell them how to capitalize on their prestigious college degrees? What was Jobs’ message to the overflow crowd? That a top-notch education, or brilliant track record, would not be enough to save them when, inevitably, a crisis turned their best-laid plans upside down. It’s a crucial lesson for all business leaders who invariably will experience hardships in business.   Lesson #1: When Crisis Strikes, Focus on the Future Jobs told his audience that it would be their ability to create anew—rethink, reimagine, and reinvent the future—that would ultimately shape their long-term success. As was the case when Jobs was forced out of his job at Apple. “I didn’t see it then, but it turned out that getting fired from Apple was the best thing that could have happened to me,” Jobs said. “It freed me to enter one of the most creative periods in my life. The heaviness of being successful was replaced with the lightness of being a beginner again, less sure about everything.” Over the next five years, Jobs introduced a revolutionary new computer operating system called NeXTSTEP, which became a critical building block of the internet. He also purchased and reinvented Pixar, a small computer graphics company, turning it into an animation company that launched a lucrative new era in filmmaking. As Walter Isaacson noted in his biography of Jobs: “He was a master at putting together ideas, art, and technology in ways that invented the future.” “Sometimes life hits you in the head with a brick,” recalled Jobs. “Don’t lose faith.” Instead, start creating the future.   Lesson #2: Creativity Is a Verb Prolific creators of all kinds have a vastly different understanding of creativity than many of us. From deep experience, they know that, contrary to what we’ve frequently been told in classrooms, books, consulting sessions, or TED talks, creativity is not a spark of genius, a personal trait to be emulated, or the unique domain of specific organizations or teams. Instead, it’s the result of a series of verbs, a strategy of actions, that any of us—whether we’re a business leader, manager, or career professional—can learn and apply to better surf the waves of business triumphs and failures and position ourselves for future success. The experience of another iconic American creator who was faced with a triple-header crisis gives a taste of the strategy.     Premium Accounting and Tax Assistance - call Nicholas Kilpatrick at 604-327-9234 to find out more for your business and click here to see our latest first-time offers.     Lesson #3: Pay Attention to the Evolving Market In the 1920s and early ‘30s, three consecutive crises barreled down on Walt Disney’s business and career track when he initially tried to get started in Hollywood. First, Universal Pictures finagled him out of the rights to his first major cartoon character and hit movie. Second, theater owners refused to show films he subsequently made. Finally, and you would think this would be the last straw, the Great Depression struck. But through it all, Disney focused on an observation that only he, among filmmakers, had made about the quickly evolving movie marketplace: audiences of all ages, especially children, loved seeing cute little animals with human characteristics and personalities. As Disney put it: “Unless people can identify themselves with the character, its actions will seem unreal. And without personality, a story cannot ring true.” Making this observation while in the throes of crisis was the first step, the initial act, in Walt Disney’s creative strategy—the underpinning of a process that led to the invention of Mickey Mouse and the subsequent launch of Disney’s entertainment empire in the depths of the Great Depression. Wrote one chronicler of the times: “Mickey Mouse became the one thing people could smile about. His indomitable spirit, as well as the technological advances that Disney displayed in those first cartoons, struck a chord with movie-going audiences. People became invested in Mickey Mouse. In rooting for Mickey, audiences were cheering their own success, as well.” The worse the economy became, the more Mickey was in demand. And by 1938, when there was light at the end of the tunnel, Mickey was credited not only with spreading joy, but with concretely assisting America’s recovery, as the production of hundreds of Mickey Mouse branded products—from wristwatches to playing cards, pencils, marmalade, breakfast cereal, table covers, and bracelets—helped to reopen factories, and provide thousands of new jobs. In a time of deep national crisis, Walt Disney observed the evolving marketplace, and with this as his starting point, built a global business like nothing the world had seen. When he was asked, as he often was over the years, how he first began creating his entertainment conglomerate, he was known to respond: “I hope we never lose sight of one thing—that it was all started by a mouse.”   Nicholas Kilpatrick is a partner at the accounting firm of Burgess Kilpatrick  in Vancouver, B.C.  He concentrates his practice on assisting business owners with accounting services, tax and estate planning and overall business development. The post What Steve Jobs and Walt Disney Can Teach Us About Turning a Crisis into Success appeared first on Real Leaders.

Leading Tax Advice Call Nicholas Kilpatrick 604-612-8620    

Leading Tax Advice Call Nicholas Kilpatrick 604-612-8620 Eight out of ten startups fail, and how badly do you think the entrepreneurs behind the failed businesses wish they could go back to their old jobs? Well, the good news is, if you follow some of the tips below, you may be able to go back to your job if your startup doesn’t work out the way you hoped: • If you’re working on your business ideas outside the hours you’re working for your employer, that’s okay. If you’re working on your business while you’re at work, however, that’s stealing. It may be difficult to focus on the job you’re doing when your head is filled with dreams of starting your own business, but, you have to buckle down and do great work. This is the last chance you’ll have to make an impression on your employer, and you don’t want that impression to be “stole company time for personal projects.” • Maybe you’ve not written your resignation letter yet. Maybe you wrote it months ago, keep it in your back pocket at all times, and are just waiting to slap it on your boss’s desk. Regardless, make sure it’s short and sweet.
Give your employer a two-to-three-sentence letter that tells them how grateful you are for the opportunity to have worked for them, and how much you’ve learned. Your resignation letter is also your two weeks notice. Understand the situation that letter puts your employer in; they now have to find someone to fill your spot, either via a backfill or hiring. That’s going to take them time and resources. In other words, you just made more work for them. So, make sure your resignation letter is respectful, not only for the opportunity but also of the plight you’ve just put them in. Your letter of resignation is an important professional document that ends a professional relationship; the content within should reflect that.   • Whenever possible, give your employer the full two weeks of a two-week notice. If, for whatever reason, your employer needs more time from you, give it to them. People quit. You may feel like you’re the first person who has ever done this, but you’re not. What makes you stand out is either the incredibly rude and selfish things you do as an employee, or the kind, thoughtful, and helpful things you do. It’s what gets you promoted, and it's what will get you your job back if you can’t make the startup dream work. So, if your former employer needs help, and it’s in your power to help, do so.     Premium Accounting and Tax Assistance - call Nicholas Kilpatrick at 604-327-9234 to find out more for your business and click here to see our latest first-time offers.     • When you go, don’t steal the company’s clients upon departure. It’s important to start your business fresh, with a clean slate and clean reputation. Remember, as a startup, you’re small. It’s a strength: you’re nimble, customized, fast. But you’re also small as in easily crushed by a big, angry business with more reach and power than you. If a big business feels like you're threatening its ability to turn a profit, it can hit you with legal issues, suck up your cash reserves, and send your business into bankruptcy. Even just the threat of something like that can destroy your reputation. It’s better to earn your reputation and customers naturally from scratch.   • Don’t recruit your friends to jump ship. By all means, put it out there for them. Let them know what you’re planning and that there is a place for them, but don’t facilitate their departure or sow seeds of dissatisfaction with the current employer. many ways, taking an employee is far worse than taking a client. Losing an employee is losing information, revenue, and incurring the cost and energy of sourcing new talent, onboarding new employees, and getting the team back up to speed.   • Do not pocket the company stapler, a pack of stationery, or a box of pens. This is beneath you!   • Sit down with your employer and map out everything you can about what you do and how you do it. If they ask you to show someone else the ropes, do it, and take it seriously. If you leave and they call you with questions that only you can answer, answer the questions—even if you don’t like your former employer and don’t want to hear from them.   • Many entrepreneurs leave one business to start a very similar business, their way. If this is you, and you are open and willing to help your former employer, you may find that former employer will send you clients they don’t service the way you would. But if you’re not willing to help them, they won't be willing to help you. Nor will they be ready to bring you back.   • Once you hand in your letter of resignation, work extra hard. Do not, under any circumstance, coast. Not only does this let them know that you were a valuable employee, but it also reinforces what losing you represents. The ideal situation for you to quit and start your own business is one in which in your current employer says to you, “we’re going to miss you around here, and if you ever want to come back, there will always be a place here for you.”   • Once you’re gone, do not, under any circumstance, bad-mouth your former employer. New customers are sensitive to how you talk about past relationships, so this is a good practice to keep. If your former employer wants to conduct an exit interview, don’t rip them apart with ridicule about how bad your boss is (even if he is). Remember, if you don’t make it as a startup, you may be looking for another job, and this employer, being your last employer, could be a reference!   • Even if your employer makes a very persuasive counter offer, humbly refuse. The entrepreneurial itch is a reality - it won't go away until you’ve scratched it, and once you’ve handed in your resignation you need to move on. If it were about making more money, that would be different, but you’re not starting your own business because of the money, you’re doing it because you want a lifestyle change. If you want to be your own boss and chase a dream, staying for more money isn’t going to change anything besides the size of your paycheck.   • When your final day arrives, stay around, shake hands with your co-workers, tell them they’re great people, and make sure they have your contact information.   • Finally, do not burn any bridges. Even if you swear to heaven above that under no circumstances will you ever work for this employer again, don’t burn a bridge. Time changes many people’s perspectives, and when you wake up one day in the future, way before dawn (because you have to keep up with the demands of your small business), you may find yourself thinking … “my old boss wasn’t so bad.” When that day comes, you’ll wish you had that bridge!     Nicholas Kilpatrick is a partner with the accounting firm of  Burgess Kilpatrick and specializes in tax structuring and business development for his small and medium business sized clients.  Please visit our website at www.burgesskilpatrick.com or on Facebook at www.facebook.com/Burgess Kilpatrick for more information on our firm.  This article was sourced from Mike Kappel, Forbes Magazine    

    Leading Tax Advice Call Nicholas Kilpatrick 604-612-8620     People tend to think of very successful (and subsequently wealthy) entrepreneurs and cultural leaders as extraordinary and singular human beings, and sometimes they are. Usually, however, they are just highly attuned, exceedingly motivated thinkers who would rather try and fail for themselves than work for someone else. Yet there are some common threads that run between world-famous entrepreneurs and cultural leaders, and one of them is daily tasks.   1.    Plan your time
Successful people tend to have a set schedule. Their schedule is arranged in advance, before that day, before that week and sometimes even months before. Of course, their schedule can change, and certain variables will alter appointments, meetings and business dinners, but starting with an organized, prearranged schedule allows busy professionals to avoid wasting time throughout the day, thinking about their next move. It seems simple and obvious, but adhering to a set schedule—in all aspects of one’s life—can help lead to success.     2.    Exercise
Successful people take time to work on their fitness goals. Whether they are working out, jogging, biking, swimming or practicing yoga, successful people understand that in order to have the energy to complete their daily tasks, they must feel good physically. Take a look at the most successful people in the world—entrepreneurs, singers, actors and actresses, CEOs, TV and film producers—and you will very likely see that almost all of them block out time for fitness, regardless of how busy the rest of their schedules are.   3.    Personal Development
Successful entrepreneurs understand that in order to maintain the level of success they have already achieved, they must continue to learn, grow and improve their craft. They often add personal development into their schedule, knowing there will always be someone who can provide them with guidance, advice and new knowledge, so these inquisitive people make time to learn something new every day. Personal development is easier than ever now; all you need is an internet connection and a laptop (or a tablet or cell phone).     Premium Accounting and Tax Assistance - call Nicholas Kilpatrick at 604-327-9234 to find out more for your business and click here to see our latest first-time offers.   You can watch industry leaders and all types of icons discuss just about any topic on TED, and you can find inspiration in your own community by listening to local leaders on TEDx. You can even take free, challenging online courses via several MOOC (Massive Open Online Courses) websites, such as Mooc List, which is an aggregate list of worldwide MOOCs. If you are a high achiever, you may prefer the remarkable selection of Ivy League MOOCs; you can take courses taught by real Ivy League professors from Brown, Columbia, Harvard (which also offers numerous video lectures, taught by some of the world’s greatest professors, through its Open Learning Initiative), Princeton, University of Pennsylvania and Yale. If you have varied interests and would like to learn about something related to your business, you can easily utilize Coursera, which offers courses on a multitude of subjects from universities. Through Coursera, you can take “Strategic Business Analytics Specialization” from the ESSEC Center for Excellence for Digital Business in France; “Think Again: How to Reason and Argue” from Duke University in North Carolina; “iOS Development for Creative Entrepreneurs” from the University of California, Irvine; “Inspirational Leadership: Leading with Sense” from HEC Paris; “Leading People and Teams” from the University of Michigan; or “Wireless Communication Emerging Technologies” from Yonsei University in South Korea. Or, just for fun, consider “Magic and the Middle Ages” from the University of Barcelona; “Greek and Roman Mythology” from Penn; or “Dog Emotion and Cognition” from Duke University. If you prefer to expand your horizons the old-fashioned way, simply pick up a book whenever you have spare time. You can even listen to audio books while you commute. Many successful entrepreneurs admit to reading over 60 books per year. How many books did you read last year?   4.      Eat Breakfast
This is another simple but overlooked task. We all know breakfast is the most important meal of the day, but not all of us live by this rule. Successful people, however, seem to take the adage more seriously. Despite schedules filled with numerous responsibilities, a variety of locations and business decisions that may seem much more important than eating breakfast, highly successful people still eat breakfast. They acknowledge that they simply do not perform as well when they are hungry (what type of performing they do is irrelevant); they are not as aggressive, not as creative, not as focused and not as motivated. For most entrepreneurs and cultural leaders, this small step is an easy way to gain a competitive edge.   5.     Reflect
Revisit successes and failures throughout the day, and consider whether or not you reached a goal, missed a deadline or grew your business. Successful entrepreneurs and cultural leaders take time to acknowledge their daily accomplishments, and also explore the ones on which they fell short. They ponder what happened, and what can be done differently in the future. A lot of successful entrepreneurs and cultural leaders contemplate their goals at least twice a day. If you compare this to average people, who tend to only scrutinize their aspirations at the end of the year (in the form of New Year’s resolutions), it becomes fairly obvious who has a clearer capacity to reach their career and personal objectives. These are just five daily tasks that all of us can implement in order to emulate some of the most successful entrepreneurs and cultural leaders in the world. Start tomorrow, with these five, expand on them as you can and be sure to let us know how you’re doing. Please feel free to add suggestions for other daily tasks in the Comments section below..   If you have any questions or want to speak further about your corporation or tax planning matters, contact Nicholas Kilpatrick at nkilpatrick@burgesskilpatrick.com   Nicholas Kilpatrick is a partner with the accounting firm of  Burgess Kilpatrick and specializes in tax structuring and business development for his small and medium business sized clients.  Please visit our website at www.burgesskilpatrick.com or on Facebook at www.facebook.com/Burgess Kilpatrick for more information on our firm. This articel was written by Devin Scott, Delaware Inc. com.    

    Leading Tax Advice Call Nicholas Kilpatrick 604-612-8620     Directors can be personally liable for employee source deductions (both the employer and employee’s portion of CPP and EI, and income tax withheld) and GST/HST unless they exercise due diligence to prevent failure of the corporation to remit these amounts on a timely basis. As many businesses are struggling with cashflow, it may be attractive to direct these amounts held in trust for the government to satisfy other creditors, such as suppliers. However, in doing so, directors may unknowingly expose themselves to personal liability if the entity is not able to remit the required source deductions and GST/HST. Director liability can extend beyond directors of a corporation to other directors, such as those of a non-profit organization. The following recent court cases highlight some of the issues related to this liability exposure: • In a July 20, 2020 Tax Court of Canada case, the use of trust funds (employee withholdings and GST/HST collected on revenues) to pay other creditors resulted in the directors being personally liable for the unremitted amounts. Their significant contributions of personal assets to pay other creditors and efforts to remedy the failure after it has occurred could not offset the lack of steps taken to prevent the failure to remit. • However, in another July 20, 2020 Tax Court of Canada case, the director was not personally liable as due diligence to prevent failure to remit was demonstrated. In this case, there was no evidence GST/HST funds had been diverted to other expenses, and significant efforts to make remittances was conducted, including prioritizing remittances over opportunities to benefit the business. Racial discrimination and sexual harassment by its customers impeded the business’s efforts to collect revenues including GST/HST. Care should also be provided to properly resign as a director to limit future exposure. CRA must issue the assessment against the directors within two years from the time they last ceased to be directors. In another July 23, 2020 Tax Court of Canada case, failure to comply with all resignation requirements under the relevant provincial corporate law meant that the director’s resignation was not legally effective, even though he had submitted a signed letter of resignation to the corporation. As he was still a director, he was still personally liable for unremitted GST/HST and source deductions.     Act Now To Get Our Value Pricing Adjustment on Audit and Review Engagements For Your Business     TAKEAWAY: Ensure all source deductions are made in a timely manner. Failing to make source deductions may expose directors personally to the liability. If you have any questions or want to speak further about your corporation or tax planning matters, contact Nicholas Kilpatrick at nkilpatrick@burgesskilpatrick.com   Nicholas Kilpatrick is a partner with the accounting firm of  Burgess Kilpatrick and specializes in tax structuring and business development for his small and medium business sized clients.  Please visit our website at www.burgesskilpatrick.com or on Facebook at www.facebook.com/Burgess Kilpatrick for more information on our firm.     [1] Haughey, Marshall, Spinoff Butterflies in Trouble?, Bennett Jones LLP. [2] Kakkar, Manu, A Critique of Canada’s Divisive Reorganization Rules: Should Breaking Up Be So Hard To Do?, Canadian Tax Foundation, Vol. 49 No. 4.

    Leading Tax Advice Call Nicholas Kilpatrick 604-612-8620       The Tax Court Of Canada decided on a case involving a number of expenses claimed by taxpayers (a corporation and its sole individual shareholder) in respect of the business of selling financial products and providing financial planning advice. CRA denied various expenses spanning multiple years and assessed many of them as shareholder benefits. That is, the amounts were taxable to the individual shareholder and not deductible to the corporation. CRA also assessed beyond the normal reassessment period on the basis that the taxpayers made a misrepresentation attributable to neglect, carelessness, wilful default or fraud. They also assessed gross negligence penalties which is computed as the greater of 50% of the understated tax or overstated credits related to the false statement or omission, and $100. The following expenses were reviewed: • bonuses paid to family members who were not employees of the taxpayer; • payments to family members under an Employee Profit Sharing Plan (EPSP) where there was no evidence that the payments referred to profits;
• salaries paid to family members (including the shareholder’s daughter who received a salary of $5,000 for the years in question); • salaries paid to the taxpayer’s children’s care providers; • salaries to the taxpayer’s former spouse, which the taxpayer argued was the same as personally paying spousal support; • travel costs for the taxpayer and his family to go on a cruise on which the taxpayer made business-related presentations (CRA conceded the taxpayer’s travel costs); • significant interest expense with very little support; and • many other costs such as clothing, toys, jewelry, personal items, lawncare, maid service, and pet care for the shareholder and family members.     While the taxpayer originally claimed the travel expenses for the taxpayer’s family to travel to Hawaii for a shareholders’ meeting, the taxpayer conceded these amounts. The taxpayer argued that any benefits taxable to him personally were conferred by virtue of his employment, not his shareholdings, and, therefore, should be deductible to the corporation.   Taxpayer loses In dismissing the taxpayer’s argument, the Court found that the vast majority of expenses reviewed were personal in nature and denied the deduction. The Court also found the vast majority of denied expenses to be a shareholder benefit. These expenses were not, by and large, expenses a reasonable employer would otherwise pay for the benefit of an arm’s length employee. The taxpayer, through his unfettered control, chose not to pay salaries or bonuses but rather to deduct the disallowed expenses from the corporate receipts and never report or ascribe any amount of benefit or employment income to himself.     Get Access to leading accounting and tax help. The time is now to get the right help and not waste any more effort getting mediocre results - call Nicholas Kilpatrick at 604-327-9234.     The Court upheld CRA’s assessment beyond the normal limitation period as well as gross negligence penalties, noting: • the sole shareholder’s education and training regarding complex tax integration, small business deduction strategies, and corporate/personal lifestyle structuring; • the individual unilaterally directed which expenses the corporation should deduct, even though some were clearly personal; and • the degree and scope of the upheld assessments were very large – in excess of $700,000 for the corporation and in excess of $1,100,000 for the individual, both spanning a two-year period.   The Court stated that the gross negligence penalties exist for these such situations: sophisticated taxpayers must appreciate that using corporate structures to mask inappropriate deductions and shield personal income from tax should not be done. The result of these inappropriate deductions was effectively triple taxation – corporate tax on disallowed deductions, personal tax on shareholder benefits, and a 50% gross negligence penalty on both the corporate and personal taxes. It would have been much cheaper had the taxpayer taken additional salaries or dividends, and paid the additional taxes up front, rather than running personal expenses through the corporation. In the case where personal expenses are paid by the corporation, the accounts should generally be corrected by adjusting the shareholder loan account or having the individual pay the corporation back. This was not done in this case.   Takeaway As best as possible, keep business and personal expenses separate. Deducting personal expenses in a corporation can lead to a very costly bill, well in excess of the tax should the amounts have been reported correctly.     If you have any questions or want to speak further about your corporation or tax planning matters, contact Nicholas Kilpatrick at nkilpatrick@burgesskilpatrick.com   Nicholas Kilpatrick is a partner with the accounting firm of  Burgess Kilpatrick and specializes in tax structuring and business development for his small and medium business sized clients.  Please visit our website at www.burgesskilpatrick.com or on Facebook at www.facebook.com/Burgess Kilpatrick for more information on our firm.

          Nicholas Kilpatrick is a partner at the accounting firm of Burgess Kilpatrick  in Vancouver, B.C.  He concentrates his practice on assisting business owners with accounting services, tax and estate planning and overall business development.  This article was sourced from www.scotiabank.com/small business centre.

  Leading Tax Advice Call Nicholas Kilpatrick 604-612-8620   For those involved in Real Estate investing, the CRA is enhancing it’s audit activity around real estate transactions, presumably because any audit activity it takes on is a money maker.  Some of you may have already received this questionnaire.  The intention of this is to disclose information that that CRA may use to warrant (from their perspective) an audit of your real estate transactions. If you are unsure about the CRA’s enhanced audit Canada procedures and need expert assistance then we at Burgess Kilpatrick are here to help you out. In 2019, the CRA assessed $171 million more in additional gross taxes related to real estate than in the prior year, according to a CRA news release that you can find here The project is aimed at promoters, developers, and taxpayers involved in multiple real estate transactions.  The CRA believes that a substantial amount of taxpayers are transacting real estate deals that constitute an income transaction rather than a capital one, and wants to collect the additional taxes previously unpaid. To assist taxpayers, a Real estate questionnaire that the department will use to determine qualified audit candidates has been released for public use and can be referenced below. The questionnaire is designed to get information for taxing purposes only, and there is the risk that the CRA may use this information to assert a tax position on your transactions inconsistent with a fair and equitable application of the Income Tax Act. If you have such a questionnaire and need help is answering the questions that assert your position, give me a call. At Burgess Kilpatrick, we will guide you with the CRA in audit questionnaire issues and will save you from hefty tax payment.   CRA Real Estate Activities Questions (1)   If you have any questions or want to speak further about your joint venture, real estate or tax issues, contact Nicholas Kilpatrick at nkilpatrick@burgesskilpatrick.com   Nicholas Kilpatrick is a partner with the accounting firm of  Burgess Kilpatrick and specializes in tax structuring and business development for his small and medium business sized clients.  Please visit our website at www.burgesskilpatrick.com or on Facebook at www.facebook.com/Burgess Kilpatrick for more information on our firm.    

    Leading Tax Advice Call Nicholas Kilpatrick 604-612-8620   In the midst of the competitive business environment they find themselves in, professional dental operators by and large recognize the need to manage their practices not only in the present (ie: to attract revenues today), but also to lay the foundation for additional, referral revenue for the future. As the apt saying states, each service is an advertisement for the next.  Also, as we’ve stated in previous posts, there is no better time to advertise than when you are face to face with your patient. Such advertising is not defined as exclusively pushing additional treatments on the patient – you as the dentist will recognize the time and place for that to happen.  Rather, quality face-to-face advertising with a high return for your practice is in the form of a more personal engagement. Engagement is the medium of marketing in our economy.  Digital marketers and advertisers daily assert with loud vocal trumpets the need to engage online, and this constitutes a necessary cog in the marketing arsenal of any business, especially dentists.  The need to engage, however, has become all the more necessary AS A RESULT OF the pervasive perceived demand to engage online. Personal engagement is the time to build trust.  Online mediums have afforded us all the opportunity to commence, develop, and track engagement online until that key time when engagement turns from digital to personal, thereby denoting a spike in the trust relationship and a signal of a new patient. We tackle the process of sustained growth in other posts, but without complementing the drivers that lead to growth in the practice with proper management of those clients brought into the fold, those clients become exposed to overtures from competitors, feelings of indifference, and compliance-like attitudes such as “let’s get this over with” How can the practitioner turn the complaint visit to the dentist into an engaging experience?    Our research suggests that doing exactly this will increase client services, as well as referrals.  Turning visits to engagements is, in our opinion, the key to complementing practice growth and proper management of that growth. About 5 years ago, some restaurants began offering to waiting patrons small samples of their menu offerings at no charge, a decision considered by many to be wise not only because it gave patrons the desire to order the full size of the menu items tasted, but also because the offering differentiated those restaurants from their competitors and established rapport with visiting customers. Dentists would be well-served to employ the same strategy – provide an environment and offerings that differentiate you from competitors and that prepare the patient for, among other things, cross-selling opportunities.   Office offerings Many visiting the practice are either working men and women, or are bringing their children to the dentist.  They need a place to engage with their work, since time in this economy is valuable.  Therefore, it’s a smart idea to offer free wi-fi and data plug-ins at your practice so that they can turn this “down-time” into productive time. It’s amazing how free coffee and finger foods sell people.  We know that coffee is not the best thing to have prior to a dental check-up, so provide them with a toothbrush and toothpaste to clean up afterwards.  The key is to provide something that you know they want, so that you can build rapport and trust. There are dental practices that are, similar to bank branches, installing tables with Ipads.  We see these tables at Apple Stores across North America.  To install 2 tables, each with 2 Ipads, allows for children to play, parents to engage in research, and provides the look of a modern practice.  This also extends to the perceived quality of your dentistry.   Dentist interaction The intent is that, by the time patients see you, they consider your practice as relevant and modern, with quality dentistry that complements the look and feel of the place.  Barriers to personal communication to facilitate trust are weakened, and the likelihood of the dentist being able to have a valuable conversation leading to the identification of birthdays, personal events, and important issues in the lives of their patients increases. You the dentist take that information and continue an offline (ie: once the patient is away from the office) relationship by sending birthday cards, reminder check-up cards with personal notes, and gift baskets to your patients to keep engaged.  It’s this continuing engagement that precedes the referral of you by those clients.   As well, the differentiation between you and competitors is broadened. You’re trying to do things that few other dentists do in order to provide an experience leading to patient retention, increased business, and increased referrals. Few dentists do this because they thing there is little or no time to do it.  However, a 5-minute conversation tacked on to the end of the appointment is not going to dismantle the daily schedule, especially if it’s built into the appointment.  Plus, you’re trying to prep the patient as much as possible by providing enhancements at the practice that set it apart and provide enjoyment to the patient while they wait. Incorporating this, get suggestion cards out the waiting area with the question – “what would you like to see at our dental practice”.  You won’t get all the patients responding, but if you get some who suggest ideas that will separate your practice from others, then you have another idea that can possible build value and trust in the minds of current and potential patients. Growth in the dental practice is the combined result of a well-considered and implemented marketing plan, a well-trained staff in the skills of cross-selling and personal interaction with patients, and personnel who know how to do dentistry, hygiene, and dental assisting. However, sustaining that growth and facilitating referral business is , we believe, the result of taking steps that differentiate the practice, the dentist, and the experience of the patients coming to the practice. These items do not take many hours and dollars to implement; in most cases, they are little things that enhance the experience of the patient and prep them for good, quality conversations with the dentist during which, hopefully, they will be open both to referring you and to additional dental services.   Just as in the digital world, the concept of quality and regular engagement is the key to sustained growth.     Nicholas Kilpatrick is a partner at the accounting firm of Burgess Kilpatrick, CPA’s in Vancouver, B.C, Canada.  The firm specializes in dental practices and business development, providing operational, strategic and data analytic support.  Nicholas  works with practice owners to increase profitability at all stages of their practice.  He can be reached at nkilpatrick@burgesskilpatrick.com or at 604-327-9234.

  Joint Ventures are increasingly being used by Real Estate Investors to suitably combine financial capital with pro rated risk exposure, and the structure provides a comfortable legal and logical framework for many investors, beginner and veteran alike.  This article summarizes a few components of a Real Estate Joint Venture (JV) Structure.       Leading Tax Advice Call Nicholas Kilpatrick 604-612-8620   What is a Real Estate Joint Venture (JV)?  A real estate joint venture (JV) is a deal between multiple parties to work together and combine resources to develop a real estate project. Most large projects are financed and developed as a result of real estate joint ventures. JVs allow real estate operators (individuals with extensive experience managing real estate projects) to work with real estate capital providers (entities that can supply capital for a real estate project). The basic principle surrounding a Real Estate Joint Venture can be illustrated through the following example. Company X owns a plot of land in the city of Winnipeg. However, Company X is based out of Halifax. John was born in Winnipeg and grew up there. In addition, John lives next to the plot of land. Company X wants to develop the land and build an office block there. Company X gets into a Joint Venture with John where Company X takes care of the capital and John provides the expertise.   The Different Players in a Real Estate Joint Venture  As mentioned above, most real estate joint ventures are comprised of two separate parties: the operating member (also called “agent”) and the capital member (also called “beneficial owners”). The operating member is usually an expert on real estate projects and is responsible for the daily operations and management of the real estate project. A typical operating member is usually a highly experienced professional from the real estate industry with the ability to source, acquire, manage, and develop a real estate project. The capital member usually finances a large part of the project or even the entire project.  The operating member is normally responsible for GST and other tax remittances and returns that may be required. In a Real Estate Joint Venture, each member is liable for profits and losses relating to the joint venture. However, this liability only extends as far as the particular project that the joint venture was created for. Aside from this, the joint venture is separate from the members’ other business interests.   Structure of a Real Estate Joint Venture  In most cases, the operating member and the capital member of the real estate joint venture set up the Real Estate project as corporation. The parties sign the joint venture agreement, which details the conditions of the joint venture. such as its objective, the contribution of the capital member, how profits will be split, delegation of management responsibilities for the project, ownership rights of the project, etc. However, a real estate joint venture is not limited to a corporation. Partnerships, and several other business arrangements can all be used to set up a joint venture. The exact structure of the JV determines the relationship between the operator and the capital provider.     Act Now To Get Our Value Pricing Adjustment on Audit and Review Engagements For Your Business     Key Aspects of a Real Estate JV Agreement A real estate JV agreement involves the following factors:  

Distribution of profits:

An important distinction to make when drafting the terms for a joint venture is how the members will distribute profits generated from the project. Compensation may not necessarily be equally distributed. For example, more active members, or members that have invested more into the project may be compensated better than passive members.  

Capital contribution

The JV agreement needs to specify the exact amount of capital contribution expected from each member. In addition, it must also specify when this capital is due. For example, a capital owner may agree to contribute 25% of the required capital but only if this contribution is made at the last stage of the development process (last money in).  

Management and control

The JV agreement is expected to specify in detail the exact structure of the JV and the responsibilities of both parties regarding the management of the Real Estate JV project.  

Exit mechanism

It is essential for a JV agreement to detail how and when the JV will end. Usually, it is in the best interest of both parties to make the dissolution of the JV as economical as possible (i.e., avoid legal fees, etc.). In addition, the JV agreement must also list out all the events that might allow one or both parties to trigger a premature dissolution of the JV.   Reasons to Form Joint Ventures Real estate development partners enter into joint ventures for the following reasons:  

• Complements - Managing partners bring industry expertise and put time and effort to manage the project, while limited partners provide the capital required to fund the project.

 

• Incentives - Managing partners are often provided with disproportionate returns to keep them motivated to work hard.

 

• Structures - Investors possess limited liability and liquidation preference in the case that the assets of the partnership are liquidated.

  Other Uses of JV Agreements A joint venture agreement also enables businesses to take part in investment projects that they normally would not be able to join. Primarily, it allows a company (home company) to invest in projects in other countries by entering into a joint venture with a local partner. In this case, the home company may either be the operating partner or the capital partner.   If you have any questions or want to speak further about your joint venture, real estate or tax issues, contact Nicholas Kilpatrick at nkilpatrick@burgesskilpatrick.com   Nicholas Kilpatrick is a partner with the accounting firm of  Burgess Kilpatrick and specializes in tax structuring and business development for his small and medium business sized clients.  Please visit our website at www.burgesskilpatrick.com or on Facebook at www.facebook.com/Burgess Kilpatrick for more information on our firm.    

    Leading Tax Advice Call Nicholas Kilpatrick 604-612-8620     Canada’s deemed dividend rules as found in section 84 of the Income Tax Act (ITA) are both cumbersome and complicated to understand.  Canadian corporate taxpayers must heed to this section of the Act, however, because actions taken can easily cause a slip into the myriad rules that surround this section of the Act.   Introduction – The What And Why of a Deemed Dividend What is a deemed dividend? Even in the absence of an explicit distribution from a corporation to its shareholder, Canada’s income-tax law forces the shareholder to recognize dividend income when certain transactions take place. These deemed-dividend rules are found in section 84 of Canada’s Income Tax Act. Yet a deemed dividend is still a dividend. In other words, a deemed dividend qualifies for the tax treatment that would otherwise apply to a conventional dividend. For example, a deemed dividend to an individual shareholder qualifies for the dividend tax credit. Similarly, just like it can with a conventional dividend, a corporation can designate the deemed dividend as a capital dividend if the corporation has a balance in its capital dividend account. Capital dividends are tax free for the recipient. Further, like conventional inter-corporate dividends, a deemed dividend from one corporation to another is fully deductible for the recipient under subsection 112(1) of the Income Tax Act. Why does Canada’s Income Tax Act contain deemed-dividend rules? Generally, these rules serve two purposes. First, Canada’s tax law allows a shareholder to withdraw a capital contribution from the corporation on a tax-free basis. The deemed-dividend rules preserve the integrity of this system by ensuring that corporate distributions exceeding contributed capital are taxed as dividends. Second, Canada generally taxes capital gains at a lower rate than that applied to dividends. The deemed-dividend rules hinder some transactions under which taxpayers could convert otherwise taxable dividends into capital gains–an effort known as “surplus stripping.” Like What You're Reading? Read More at:     After examining the concepts of stated capital, paid up capital, and adjusted cost base, this article discusses the deemed-dividend rules found in subsections 84(1), 84(2), 84(3), and 84(4) of the Income Tax Act. Important Concepts: Stated Capital, Paid Up Capital, and Adjusted Cost Base To understand the mechanics of the deemed-dividend rules, you need a handle on three important concepts: stated capital, paid up capital, and adjusted cost base.   Stated Capital A corporation’s stated-capital account tracks the consideration that the corporation received in exchange for issuing its shares—in other words, the account tracks the amount paid by the shareholder to the corporation. The corporation will keep a separate stated-capital account for each class or series of shares. And proper accounting should allow you to discern the stated capital for each issued share. The corporation’s stated capital reveals the shareholders’ skin in the game. The stated-capital account shows how much the shareholders have invested in the corporation. Because the stated capital represents the amount that shareholders commit to the corporation, it serves as a measure of shareholders’ limited liability. That is, the stated-capital account shows exactly how much the shareholders have risked by investing in the corporation. As a result, it alerts potential future investors or lenders of risk when investing or lending to a corporation. Generally, the stated-capital account tracks the fair market value of the consideration that the corporation received upon issuing a class or series of shares. But, in certain circumstances, corporate law allows the corporation to increase its stated capital by less than the full fair market value of the consideration received. The amount of the consideration that isn’t added to the stated capital is called a “contributed surplus,” and it can later be capitalized and added to the appropriate stated-capital account. In addition, the stated-capital account for a class or series of shares must decrease if the corporation purchases, acquires, or redeems shares in that class or series.   Paid Up Capital (PUC) Paid up capital (PUC) measures the contributed capital and capitalized surpluses that a corporation can return to its shareholders on a tax-free basis. Paid up capital and stated capital are closely related concepts. The corporation’s stated capital serves as the basis for computing the paid up capital of its shares. And, like stated capital, PUC is an attribute of each issued corporate share. But PUC may deviate from stated capital. Stated capital is a corporate-law concept; paid up capital is a tax-law concept. So, while PUC derives from stated capital, the two may diverge. For example, say you bought a property for $50,000 a few years ago. Now, the property is worth $100,000, and you transfer that property to a corporation in exchange for a single share, thereby incurring a capital gain. Your share’s stated capital and PUC will each be $100,000. In contrast, say you transferred the same property to the corporation under section 85 of the Income Tax Act, which allows you to effect the transfer at the property’s cost and thus avoid incurring a taxable capital gain. In this case, your share’s PUC will be $50,000, and its stated capital will be $100,000. (A section 85 rollover typically qualifies as a circumstance where corporate law allows a reduced stated capital. So, experienced Canadian tax planning lawyers will often adjust the stated capital to match the PUC. The default, however, is a mismatch.)       Premium Accounting and Tax Assistance - call Nicholas Kilpatrick at 604-327-9234 to find out more for your business and click here to see our latest first-time offers.   Adjusted Cost Base (ACB) The adjusted cost base (ACB) is the shareholder’s tax cost for purchasing the shares. The ACB, when deducted from the proceeds of disposition, determines the amount of a capital gain or capital loss when the shareholder disposes of the shares. The ACB is an attribute of the shareholder; stated capital and PUC are attributes of the shares. So, the shareholder’s ACB for a share need not accord with the share’s stated capital or PUC. The stated capital and PUC only capture a shareholder’s contribution to the corporation for a share; the ACB captures a shareholder’s contribution to any vendor for a share. To illustrate, we continue with the example above: you transfer that property worth $100,000 to a corporation in exchange for a single share. Your share’s stated capital and PUC will each be $100,000. And your ACB will also be $100,000. You later sell your share to a buyer for $150,000. The corporation gets nothing out of this transaction. So, the share’s stated capital and PUC each remain at $100,000. But the buyer paid $150,000 for the share. So, the buyer’s ACB is $150,000.   Deemed Dividend Upon an Increase of PUC: Subsection 84(1) Subsection 84(1) deems a corporation to have paid a dividend on a class of shares for which the corporation has increased PUC. In turn, paragraph 53(1)(b) increases the shareholder’s share ACB by the amount of the deemed dividend. The ACB bump ensures that the shareholder isn’t double taxed when selling the affected shares. But subsection 84(1) doesn’t apply and no deemed dividend will arise if the increase in PUC resulted from any of the following:

• the payment of a stock dividend (i.e., a corporation’s capitalizing retained earnings);
• a transaction where the PUC increase matches either an increase in the corporation’s net assets or a decrease in the corporation’s net liabilities;
• a transaction where the PUC increase matches a PUC decrease for shares in another class; or
• conversion of contributed surplus into PUC (i.e., a corporation’s capitalizing contributed surplus).

  For example, a corporation issues shares with a PUC of $500 to a creditor in settlement of a $450 debt. (The corporation didn’t decrease the PUC of any other share class.) As a result, the creditor receives a deemed dividend of $50 ($500 PUC minus $450 decrease in liability). And the creditor’s ACB for the shares is $500 ($450 initial ACB plus $50 deemed dividend).   Deemed Dividend Upon Winding Up: Subsection 84(2) When a corporation is wound up or liquidated, its assets are sold, liabilities paid, and the remaining cash is distributed to the shareholders thus canceling their shares. Under subsection 84(2), upon the corporation’s liquidation or winding up, any property or cash distributed to a shareholder in excess of a share’s PUC is deemed a dividend. But when computing the capital gain for disposing the shares, the shareholder reduces the liquidation proceeds by the amount of the deemed dividend. This ensures that the shareholder’s liquidation proceeds aren’t double taxed as both deemed dividends and capital gains. For example, after selling its assets and paying its liabilities, the liquidating corporation pays $800 to its shareholder in cancelation of shares with PUC of $200. The shareholder’s ACB for the shares is also $200. As a result, the shareholder receives a deemed dividend of $600 ($800 distributed minus $200 PUC). And the shareholder’s capital gain is nil ($800 distributed minus $600 deemed dividend minus $200 ACB). The deemed-dividend rule in subsection 84(2) doesn’t apply if: (1) subsection 84(1) applies to the same transaction; or (2) the corporation’s share purchase for cancellation was an open-market transaction.   Deemed Dividend Upon Share Redemption: Subsection 84(3) A share redemption occurs when a corporation purchases its shares from a shareholder and cancels those shares. Subsection 84(3) deems the shareholder to have received a dividend to the extent that the redemption proceeds exceeded the share’s PUC. But when computing the capital gain for disposing the shares, the shareholder offsets the redemption proceeds by the amount of the deemed dividend. This ensures that the shareholder’s redemption proceeds aren’t double taxed as both deemed dividends and capital gains For example, a corporation redeemed its shares and paid the shareholder $200. The shares had a PUC of $75, and the shareholder’s ACB for the shares was also $75. As a result, the shareholder received a deemed dividend of $125 ($200 redemption price minus $75 PUC). And the shareholder’s capital gain is nil ($200 proceeds of disposition minus $125 deemed dividend minus $75 ACB). The deemed-dividend rule in subsection 84(3) doesn’t apply if: (1) subsection 84(1) applies to the transaction; (2) the corporation’s share purchase for cancellation was an open-market transaction; or (3) the redeeming corporation was a public corporation.   Deemed Dividend Upon a Reduction of PUC: Subsections 84(4) and 84(4.1) Subsection 84(4) applies where a Canadian resident corporation reduced its PUC for any class of shares. Generally, a corporation reduces its PUC when it pays a tax-free return of capital to its shareholders. Subsection 84(4) anticipates situations where the corporation pays an amount exceeding the appropriate corresponding decrease in PUC. Basically, the provision says that, to the extent that the payment exceeds the amount of the PUC reduction, it is deemed a dividend. Moreover, subparagraph 53(2)(a)(ii) accounts for the tax-free return of capital by reducing the ACB of the shareholder’s shares. The provision reduces the ACB in proportion to the PUC reduction of the shareholder’s shares. For example, a shareholder owns a share with an ACB of $10 and PUC of $10. The corporation pays the shareholder $8 as a return of capital but only reduces the share’s PUC account by $7. As a result, the shareholder receives a deemed dividend of $1 ($8 distribution minus $7 PUC reduction). The shareholder’s ACB for the share is reduced by $7. So, the shareholder owns a share with an ACB of $3 and PUC of $3. So, subsection 84(4) permits a private corporation to distribute a tax-free return of capital so long as the distribution corresponds with the PUC reduction. But public corporations can only distribute a tax-free return of capital in limited circumstances. Subsection 84(4.1) applies to public corporations. The general rule deems as a dividend any payment by a public corporation to its shareholders even if the payment doesn’t exceed the reduction of PUC. In other words, public corporations generally can’t pay a tax-free return of capital to their shareholders. The public corporation may, however, pay a tax-free return of capital to its shareholders only if the amount came from proceeds that the corporation realized from a transaction “outside the ordinary course of the business of the corporation.” This carve out allows a public corporation to, say, sell a business unit and distribute the proceeds to its shareholders as a return of capital.   Tax Tips – Deemed Dividends The corporation’s stated capital need not accord with PUC. This inconsistency is a common trap for those relying solely on the corporation’s financial statements. Unaware that share capital exceeds PUC and issuing what appears to be a tax-free return of capital, inexperienced accountants and corporate lawyers often trigger deemed dividends for their clients. Consult one of our experienced Canadian tax lawyers to review pending transactions or for advice on reducing the risk of a deemed dividend. For instance, one simple strategy is to reduce the corporation’s stated capital so that it matches the PUC.     If you have any questions or want to speak further about your corporation, contact Nicholas Kilpatrick at nkilpatrick@burgesskilpatrick.com   Nicholas Kilpatrick is a partner with the accounting firm of Burgess Kilpatrick and specializes in tax structuring and business development for his small and medium business sized clients.  Please visit our website at www.burgesskilpatrick.com or on Facebook at www.facebook.com/Burgess Kilpatrick for more information on our firm.     

    Leading Tax Advice Call Nicholas Kilpatrick 604-612-8620     As part the 2018 budget, the federal government announced two proposed measures to restrict the tax advantages of earning passive investment income in a private corporation:

• Limiting access to the small business tax rate
• Limiting access to refundable taxes

This article focuses on the second measure by explaining changes to the rules for obtaining a refund from the refundable dividend tax on hand (RDTOH) account that were proposed in the budget.   Refundable dividend tax on hand (RDTOH) Canada has a tax system for Canadian private corporations and their shareholders that is built on the concept of “integration.” Briefly, this means an owner earning investment income in a corporation should pay the same amount of tax on that investment income as they would pay if such income was earned personally. Part of integration is a refundable tax mechanism, refundable dividend tax on hand (RDTOH), that applies on income earned from passive investments held in a private corporation. Generally, under this mechanism, passive investment income earned by a Canadian controlled private corporation (CCPC), such as interest, rents, royalties, taxable capital gains and portfolio dividends from foreign corporations, is subject to a higher tax rate than active business income, and a portion of that higher tax is refunded to the corporation when it distributes taxable dividends to its shareholders. Subjecting such investment income to a higher tax rate up front can reduce the incentive of retaining this income in a private corporation. There are generally two components to the RDTOH account in a corporation. The first arises from “Part 1 refundable tax,” and the second from dividends received from other corporations. These two components are discussed in further detail below.   Part I refundable tax Let’s consider how the refundable tax mechanism works in more detail. Passive income earned by a CCPC is taxed at a high combined corporate tax rate, ranging from 50.17 percent to 54.67 percent in 2018 (depending on the province or territory). This includes a federal refundable tax of 10.67 percent. The combined rate is much higher than the combined general tax rate that applies to active business income (which ranges from 26.5 percent to 31 percent depending on the province or territory). The refundable portion of the taxes (i.e., 30.67% of investment income) is added to the corporation’s RDTOH) Note that foreign investment income on which a foreign tax credit is claimed results in an adjustment that reduces the RDTOH account. A tax refund is allowed to the corporation upon payment of a taxable dividend. The refund is determined at a rate of 38.33 cents for every $1 of taxable dividends paid, limited to the balance in the RDTOH account. Taxable dividends are classified as either eligible or non-eligible, and this determines the rate of tax applicable to the receiving individual shareholder. Eligible dividends are paid from the active business income taxed at the general corporate rate. Non-eligible dividends are generally paid from active business income taxed at the small business rate or from passive investment income. It is important to note that eligible dividends are taxed in the hands of the individual shareholder at a lower rate than non-eligible dividends. For example, in British Columbia, the current 2018 tax rate on eligible dividends to an individual taxable at the top rate is 34.19 percent, while the equivalent rate on non-eligible dividends is 43.73 percent. The rates on both types of dividends vary by province or territory. Currently, the payment of either an eligible or non-eligible dividend will generate a dividend refund where the corporation has an RDTOH account balance. This means that a corporation can receive an RDTOH refund upon the payment of a lower-taxed eligible dividend sourced out of business income taxed at the general corporate rate in situations where the RDTOH was generated from investment income that would need to be paid out as a higher-taxed non-eligible dividend. This can result in a tax deferral advantage — the corporation gets tax refunded, plus the individual pays lower tax on the eligible dividend. The higher-rate personal tax on the non-eligible dividend is effectively deferred until a non-eligible dividend sourced from investment income is paid. Assuming the top personal tax rates for 2018, deferral of personal tax when an eligible dividend is paid to generate a dividend refund for the corporation ranges from 1.2 percent to 13.37 percent depending on the province or territory. This is the tax rate differential between eligible dividends and non-eligible dividends.     Get Access to leading accounting and tax expertise. Call Nicholas Kilpatrick at 604-327-9234.     Dividends received from other corporations The explanation above deals with the RDTOH account that arises from tax on investment income earned in the corporation, also known as Part I refundable tax. However, there is a second component of the RDTOH account, and that comes from dividends received from other corporations. When a corporation holds portfolio investments in other Canadian corporations, dividends from these corporations are not subject to regular corporate tax, but are subject to a fully refundable tax of 38.33 percent, known as Part IV tax. For dividends from non-portfolio, or “connected” corporations (where there is at least 10 percent ownership), these dividends can be received tax-free, except where the recipient corporation must pay tax equal to the amount of tax refunded to the payor upon payment of a dividend. In that case, the tax is added to the recipient’s RDTOH account.   The budget’s new rules To eliminate the tax deferral advantage, the budget proposes that a refund of RDTOH will only be available where a private corporation pays non-eligible dividends, with one exception for RDTOH that arises from eligible portfolio dividends received by a corporation. This new measure will apply to taxation years that begin after 2018. To implement the change, there will be two separate RDTOH accounts. The current RDTOH account will be known as “non-eligible RDTOH” and will track refundable taxes paid under Part I on investment income, as well as under Part IV on non-eligible inter-corporate dividends. Refunds from this account will be obtained only when non-eligible dividends are paid. A new RDTOH account, known as “eligible RDTOH,” will track refundable taxes paid under Part IV on eligible portfolio dividends. Under the proposed changes, the payment of a non-eligible dividend can result in a refund from the eligible RDTOH account only when there is no balance left in the non-eligible RDTOH account. Otherwise, only the payment of an eligible dividend will result in a dividend refund from the eligible RDTOH account. As noted above, where a corporation pays a dividend to a connected corporation, the recipient pays refundable tax equal to the amount of tax refunded to the payor and the tax is added to the recipient’s RDTOH account. Under the proposals, this rule will continue and the account for the RDTOH addition for the recipient corporation will be matched to the RDTOH account from which the payor corporation obtained its refund.   RDTOH transition rule There is a special transition rule that will apply to allocate the existing RDTOH balance of a CCPC between the two separate RDTOH accounts. Specifically, the amount allocated to the CCPC’s eligible RDTOH account will be equal to the lesser of the CCPC’s existing RDTOH balance and an amount equal to 38.33 percent of the balance of its general rate income pool (GRIP). Any remaining balance will be allocated to its non-eligible RDTOH account. For any other corporation, such as private corporations that are not CCPCs, the existing RDTOH balance will be allocated to the corporation’s eligible RDTOH account. This transition rule applies to a corporation’s first taxation year in which the new eligible RDTOH account becomes applicable. Note that an anti-avoidance rule will apply to prevent the deferral of the application of this measure through the creation of a short taxation year.   If you have any questions or want to speak further about your corporation, contact Nicholas Kilpatrick at nkilpatrick@burgesskilpatrick.com   Nicholas Kilpatrick is a partner with the accounting firm of  Burgess Kilpatrick and specializes in tax structuring and business development for his small and medium business sized clients.  Please visit our website at www.burgesskilpatrick.com or on Facebook at www.facebook.com/Burgess Kilpatrick for more information on our firm.     

    Leading Tax Advice Call Nicholas Kilpatrick 604-612-8620     Income splitting among family members can be beneficial largely because of the graduated tax rates used in our income tax system. All provinces similarly have graduated tax rates.  As a result, if you are in a lower tax bracket than your family members, the splitting of income can subject the income to a lower rate of tax. In addition, their tax credits can further reduce tax payable on the split income. The government is aware of this potential tax savings, and generally frowns on income splitting. As a result, there are various income attribution rules that can apply if you transfer property to your spouse (or common-law partner) or minor children.  These rules are summarized below, followed by  the major exceptions to the rules.   Loans or Transfers to Spouse Attribution can apply if you lend or transfer money or property to your spouse (or common-law partner), including a loan or transfer before you became spouses. Under this rule, income or loss from  the property (or property substituted for that property) is attributed to you and included in your income (or loss) rather than your spouse’s income. Income from property includes items such as interest, dividends and rent. A similar attribution rules Canada can apply to attribute taxable capital gains (or allowable capital losses) from your spouse’s dispositions of the property or substituted property. The substituted-property rule means attribution can continue even if your spouse sells or converts the lent or transferred property and uses the proceeds to acquire another property. For example, if you give your spouse cash and she uses the cash to purchase corporate bonds, the interest from the bonds will be attributed to you. Furthermore, if she sells the bonds and uses the proceeds to buy another income-producing property, the attribution rules can continue to apply to the income or gain from that other property. The property income attribution stops if you divorce, or are living separate due to the breakdown of your marriage (or common-law relationship). The capital gains attribution ceases after divorce, but stops during your separation only if you make a joint election with your tax returns.   Loans or Transfers to Minor Children Another attribution rules CRA applies if you lend or transfer property (or money) to your child who is under 18, any other minor child with whom you do not deal at arm’s length, or your minor niece or nephew. As with the rule for spouses, income or loss from the property or property substituted for that property is attributed to you. The income attribution does not apply throughout the year in which the minor child turns 18 or in later years. However, the attribution rules do not apply to capital gains of minor children, so capital gains splitting with your minor children is generally allowed. For example, you can purchase common shares or equity mutual funds for your minor children, and subsequent taxable capital gains on the property will be included in their income and will not be subject to attribution. (But see the discussion below on the “kiddie tax”, which can apply to a minor child’s capital gains in limited circumstances.) You also have to make sure that, under the law of the province in which you live, your minor children are legally allowed to acquire and own the property in question.   Exceptions Fortunately, there are various exceptions to the attribution rules Canada. The main ones are summarized below. The rules do not apply to income from business. Therefore, you can give or lend property to your spouse or minor children to earn business income and the income will not be attributed to you. As noted, the attribution rules CRAdo not normally apply to capital gains of minor children. Therefore, you can legitimately split capital gains with them. Note however that attribution can apply if you transfer certain farm or fishing property to your child under the rollover provisions of the Income Tax Act. The rules do not apply if you lend money to your spouse or minor child at the prescribed rate of interest, as long as they actually pay you the interest each year or by January 30 of the following year.  For example, if you lend money to your spouse at the prescribed annual interest and she uses the fund to purchase an investment that pays an annual return greater than the prescribed rate, the attribution rules will not apply provided she pays you the prescribed rate every year. She will include the excess net return in income.     Act Now To Get Our Value Pricing Adjustment on Audit and Review Engagements For Your Business   You will include the prescribed interest received by you. However, if your spouse misses or is late with even one interest payment, this exception from attribution ceases to apply. The attribution rules do not apply if you receive at least fair market value consideration for the property. Similar to the lending exception above, if the consideration is debt, you must charge at least the prescribed rate of interest, and they must pay you the interest each year or by January 30 of the following year. Also, in the case of your spouse, if you transfer property under this exception you must elect out of the tax-free “rollover” on the transfer, which is otherwise available for transfers between spouses. This means that the transfer of the property will normally take place at fair market value, which could generate a capital gain for you if the value exceeds your cost of the property. Unfortunately, because of the superficial loss rules (discussed further below in this Letter), any loss on the transfer will normally be denied. The rules do not apply to reinvested income. Thus, if you transfer property to your spouse or minor child and they reinvest the income earned on the property, the income earned on the reinvested income is not subject to attribution. The rules do not apply to transfers of property to children over 18. However, there is an anti-avoidance rule that can apply if you lend money to a relative (minor or adult) or another non-arm’s length person and one of the main reasons is to reduce your tax payable. As above, there is an exception to this anti-avoidance rule if you charge at least  the prescribed rate of interest on the loan. The rules obviously do not apply if the property generates no income or capital gains. Therefore, you can make personal expenditures for your spouse and children and not worry about any attribution rules. As a planning point, consider paying most or all of your spouse’s personal expenses, common household expenses and any income tax your spouse owes, thus freeing up your spouse’s own income to invest in income-earning property. The attribution rules will not apply. Since income or capital gains from a tax-free savings account (TFSA) are not included in income, you can put cash into your spouse’s or adult child’s TFSA and there will be no attribution on any subsequent income. Similarly, as noted earlier, if you contribute to your spouse’s RRSP (provided it was set up as spousal plan), there is no attribution when the funds and income are withdrawn by your spouse, generally as long as the withdrawal does not take place in the year during which you contributed or the two subsequent years. If you receive the Universal Child Care Benefit because you have children under 18, the benefit can be invested and all income or gains from the investment are exempt from attribution provided you can track it. So it can be a good idea to put these payments into a separate bank account, if you don’t need to spend them.   Tax on Split Income of Minor Child (“Kiddie Tax”) Although not an attribution rule, the kiddie tax can apply to the “split income” of a minor child. The tax is levied on the split income of the child at the highest marginal rate of tax (i.e. 33% federal, plus provincial tax). Furthermore, the only tax credits available against the tax on the split income are the dividend tax credit and any available foreign tax credits. Thus, although the income is not attributed, the kiddie tax is just as onerous or more so. “Split income” includes shareholder benefits and dividends received from shares of corporations other than publicly-traded shares and mutual funds. In general terms, it also includes certain trust or partnership income derived from services or property provided to a business in which a parent is involved (the details are somewhat complex).   If you have any questions or want to speak further about your tax situation, contact Nicholas Kilpatrick at nkilpatrick@burgesskilpatrick.com   Nicholas Kilpatrick is a partner with the accounting firm of Burgess Kilpatrick and specializes in tax structuring and business development for his small and medium business sized clients.  Please visit our website at www.burgesskilpatrick.com or on Facebook at www.facebook.com/Burgess Kilpatrick for more information on our firm.  This article has been paraphrased from an article by Pierre-Yves Daoust, Marcil Lavallee.  

    Leading Tax Advice Call Nicholas Kilpatrick 604-612-8620     The 2018 federal Budget includes a measure designed to slow the accumulation of passive investments within active corporations. This measure is based on a calculation that considers both the amount and the type of investment income earned in a corporation. Understanding this calculation will guide an investor in developing a tax-efficient investment strategy going forward.[3]   The calculation Aggregate investment income (AII) is carved out from active business income and is both ineligible for the small business deduction and subject to a higher tax rate than ordinary business income. The definition of AII remains unchanged with the 2018 Budget but has become the starting point for the calculation of adjusted aggregate investment income (adjusted AII). A corporation is entitled to $50,000 of adjusted AII. Thereafter, its small business deduction limit decreases by $5 for every additional $1 of adjusted AII and is completely eliminated at $150,000 of adjusted AII. The calculations for AII and adjusted AII are:1          AII =               net income from property (rent, interest, royalties, etc.) +             taxable capital gains for the year (including gains from the sale of active assets) +             taxable dividends +             foreign investment income

• taxable dividends
• capital losses for the year
• capital losses from prior years applied in the year.

  Adjusted AII= Aggregate investment income (AII above) +             taxable dividends not received from a connected corporation +             capital losses from prior years applied in the year

• capital gains from the sale of active assets

  Key Differences There are three key differences between AII and adjusted AII:

Portfolio dividends, although not taxable2 and not included in AII, are included in adjusted AII.

Capital losses for the year only reduce adjusted AII in the year incurred, and only if there are adequate capital gains in that year against which they may be applied. That is, capital losses from prior years applied in the current year do not reduce a corporation’s adjusted AII.

For the purposes of AII, a capital gain is income from property, regardless of the use of the asset that generated it. For adjusted AII however, as the purpose of this new limitation is to penalize corporations with passive investments, a carve-out of capital gains from active assets is permitted. For these purposes, an active asset is one used principally in an active business carried on primarily in Canada or by a related CCPC.

These differences provide a roadmap to managing a corporation’s adjusted AII and limiting its small business deduction clawback: Moving away from interest and dividends and toward capital gains
Only half of a capital gain is included in adjusted AII, and managing when a capital gain is triggered will provide a corporation with some control over its annual clawback. Monitoring when capital losses are triggered
Capital losses triggered in a year in which there are no capital gains to offset are wasted for the purposes of adjusted AII. Triggering capital losses in years in which large capital gains are expected will make the most of the losses. Investors should meet with their advisors before the end of each year to discuss this timing. Purchasing appreciable active assets
Investors might consider (for example) investing in the building in which they operate. The capital gain from eventual sale will not affect adjusted AII, and if structured properly, related rent can be charged and treated as active income. Tax-deferred distributions
Some investments can provide tax-deferred distributions. Consider, for example, a real estate investment trust (REIT). A portion of each REIT unit’s distribution is a return of capital, which does not affect adjusted AII and is not taxable until the unit is ultimately disposed of. Limited partnerships and mortgage-backed securities are some other common types of investments that provide tax-deferred distributions. Off-balance-sheet investing
Investors might consider funding Individual Pension Plans (IPPs). IPPs allow for higher contributions than traditional RRSPs, and funding payments, administrative costs and investment costs are fully deductible to the corporation. However, growth of the plan assets is tax-deferred and thus does not affect adjusted AII. Overfunding a life insurance policy
Life insurance policies provide the tax-deferred accumulation of investment assets (to certain limits), they do not affect adjusted AII, and they provide tax-advantaged distributions. The spirit of the small business rate available to private corporations is to provide business owners with more after-tax income to grow their businesses. This new measure is intended to curtail the ability to reinvest funds taxed at the small business rate which is consistent with Finance’s original intent. Bear in mind, after-tax business income reinvested in passive investments within a corporation – whether taxed at the small business rate of 13.5 per cent or the general rate of 26.5 per cent – still provides an initial deferral benefit that corporations can continue to use. But with some strategic investing, the benefit can be maximized to its fullest extent.     Premium Accounting and Tax Assistance - call Nicholas Kilpatrick at 604-327-9234 to find out more for your business and click here to see our latest first-time offers.   1 The calculations of AII and adjusted AII have been simplified here for illustrative purposes to include only common types of investment income.
2 Subject to 38.33 per cent refundable tax unless the dividend is received from a connected corporation.   If you have any questions or want to speak further about your corporation, contact Nicholas Kilpatrick at nkilpatrick@burgesskilpatrick.com   Nicholas Kilpatrick is a partner with the accounting firm of Burgess Kilpatrick and specializes in tax structuring and business development for his small and medium business sized clients.  Please visit our website at www.burgesskilpatrick.com or on Facebook at www.facebook.com/Burgess Kilpatrick for more information on our firm.      3 Dupuis, Scott; Managing Adjusted Aggregate Investment Income, Baker Tilly

      Leading Tax Advice Call Nicholas Kilpatrick 604-612-8620   The prospect for Canadian parent corporations to invest in foreign subsidiaries can provide multiple business opportunities that otherwise may not exist in Canada.  For example, the Canadian market for a company’s existing product line may be saturated, while competition may be low in foreign jurisdictions.  Or established business connections or relationships may facilitate expedited insertion of the company’s products or services into a foreign market[1]. If a Canadian corporation establishes or purchases a foreign subsidiary and generates profit from that subsidiary, the repatriation of profits from the foreign subsidiary to the Canadian parent presents various taxation issues – and international tax planning opportunities – that need to be considered in order to determine the viability of any proposed investment into any foreign jurisdiction.   Definition of “Foreign Affiliate” and “Controlled Foreign Affiliate” A non-resident corporation is a foreign affiliate of a Canadian parent corporation if the Canadian parent (i: “taxpayer”) owns, either directly or indirectly, at least 1 percent of any class of shares, and the taxpayer, together with related persons (whether residents or non-residents of Canada) owns, directly or indirectly, at least 10 percent of any class. The threshold for foreign affiliate status is therefore fairly low, and qualifying as a foreign affiliate can be either good or bad. If the affiliate is carrying on an active business, foreign affiliate status will give a Canadian corporate shareholder access to deductions under the exempt/taxable surplus regime. However, if the foreign affiliate is also a “controlled foreign affiliate,” any Canadian shareholders (individuals as well as corporations) will be subject to annual taxation on their pro rata share of any Foreign Accrual Property Income (FAPI). A controlled foreign affiliate (CFA) of a taxpayer resident in Canada means a foreign affiliate that is controlled by the taxpayer or the taxpayer and a person or persons with whom the taxpayer does not deal at arm’s length.   Dividends from Active Business Income Dividends paid from active business income by a foreign affiliate to a Canadian corporate shareholder may be out of “exempt surplus,” “taxable surplus,” or “pre-acquisition surplus.” Exempt surplus generally includes after-tax, active business income earned in a treaty country, provided that the affiliate is also resident in a treaty country, both under the common law principle of management and control and as defined in the applicable treaty.  Active business income earned by a foreign affiliate in a non-treaty country, or by an affiliate that is not resident, as defined, in a treaty country, is included in taxable surplus. Dividends paid by a foreign affiliate that exceed its exempt and taxable surplus accounts are deemed to come out of pre-acquisition surplus, a notional account for which no actual computations are made. Dividends received by a corporation resident in Canada from foreign affiliates are initially included in income, but deductions are then allowed for all or a portion of the dividends in computing taxable income, depending on the surplus account from which the dividend is prescribed to have been paid. Dividends out of exempt surplus are deductible in computing taxable income, irrespective of the foreign tax burden that has been incurred. Where a dividend is out of taxable surplus, deductions related to the underlying foreign tax applicable to the earnings being distributed, as well as to any foreign withholding taxes applicable to the dividends, are available. The general policy rationale is that Canadian tax will be payable on dividends out of taxable surplus only to the extent that the total foreign tax burden is less than the basic Canadian corporate tax rate. While the underlying foreign tax applicable to a dividend received While the underlying foreign tax applicable to a dividend received out of taxable surplus is generally determined on a pro rata basis according to the proportionate amount of the taxable surplus being distributed, a taxpayer can claim more than a pro rata amount if prescribed tests are met. Dividends received out of pre-acquisition surplus are deductible in computing taxable income, but the amount of such dividends, net of any foreign withholding tax, reduces the tax basis of the shares on which the dividends were paid. Dividends paid by a foreign affiliate are deemed to come first out of the affiliate’s exempt surplus to the extent available, and next out of taxable surplus. However, a taxpayer may elect to have all or part of a dividend received from a foreign affiliate treated as having been paid out of taxable surplus rather than exempt surplus. This election may be desirable where, for example, the dividend is out of low-taxed taxable surplus, and the Canadian corporation has a non-capital loss carryforward expiring in the year. Any dividend payments that exceed an affiliate’s exempt and taxable surplus balances are generally deemed to be paid out of pre-acquisition surplus.       Act Now To Get Our Value Pricing Adjustment on Audit and Review Engagements For Your Business   Taxation of FAPI Taxpayers resident in Canada must include their proportionate amount of any FAPI earned by a CFA in income on a current basis (subject to deductions in respect of underlying foreign tax), whether or not the income is distributed by the affiliate as dividend payments. These rules apply to Canadian-resident individuals as well as to corporations, and to affiliates in treaty as well as non-treaty countries. The allocable amount is based on the taxpayer’s participating percentage,10 determined at the end of each taxation year of the affiliate. If a Canadian taxpayer has an interest in a CFA at the end of a particular taxation year, there is an attribution of FAPI earned by the affiliate during the entire year; conversely, there is no attribution if the Canadian shareholder does not have an interest in a CFA at the end of a year. Generally, no further Canadian tax is imposed when FAPI is repatriated to Canada as dividend payments, although deductions may be available at that time for foreign withholding tax imposed on the dividends.  Income characterized as FAPI is included in taxable surplus and, to the extent that FAPI is earned by a foreign affiliate that is not a CFA of a Canadian taxpayer, the income is subject to potential Canadian tax when it is ultimately paid to Canada as dividends.   Determination of FAPI FAPI, as defined, includes an affiliate’s income from property and businesses other than active businesses, and taxable capital gains from dispositions of property other than “excluded property,”less the affiliate’s losses from property and businesses other than active businesses and allowable capital losses from dispositions of property other than excluded property. There is a five-year carryforward of any net FAPI losses incurred by an affiliate in a particular year.  Interaffiliate dividends are specifically excluded from the definition of “FAPI.” In addition to property income that is purely of a passive nature, FAPI includes income from an adventure or concern in the nature of trade, as well as

• income from an “investment business
• income from trading or dealing or indebtedness; and
• various types of income earned by a foreign affiliate, where the corresponding deduction erodes the Canadian tax base.

  Income from an Investment Business Income from an investment business is included in the definition of “income from property.” Under the investment business rules, where the principal purpose of a business is to earn interest, dividends, rents, royalties, or similar returns or substitutes therefor, insurance income, income from factoring accounts receivable, or profits from the disposition of investment property, the income is FAPI unless specifically exempted. Exemption generally applies if the affiliate employs more than five employees (or the equivalent thereof) full-time in the active conduct of the business, and the business is conducted principally with arm’s-length persons There are many taxation issues that exist when a Canadian parent corporation invests in a CFA, and the above is not an exhaustive discussion of all the prevalent issues.  One must consider and analyse the business and tax issues to determine if the prospective purchase of start-up of the foreign subsidiary is in the Canadian parent’s best interests.   If you have any questions or want to speak further about your corporation or estate planning matters, contact Nicholas Kilpatrick at nkilpatrick@burgesskilpatrick.com   Nicholas Kilpatrick is a partner with the accounting firm of  Burgess Kilpatrick and specializes in tax structuring and business development for his small and medium business sized clients.  Please visit our website at www.burgesskilpatrick.com or on Facebook at www.facebook.com/Burgess Kilpatrick for more information on our firm.  This article has been paraphrased from an article by Allen R. Lanthier of Ernst & Young.     [1] Lanthier, Allen R., Ernst & Young, Canadian Tax Journal, Vol 43, No. 5.

    Leading Tax Advice Call Nicholas Kilpatrick 604-612-8620     In 1981, John Robertson, then director general of the CCRA’s Corporate Rulings Directorate, presented a paper at the annual conference of the Canadian Tax Foundation setting out the Canada Customs and Revenue Agency’s (CCRA’s – as the department was then called) concerns related to the ability of  taxpayers to use the butterfly transaction to separate business and investment properties, as well as sell any asset, on a tax-deferred basis at the corporate level.  [1] The butterfly transaction introduced a complex and effective corporate tax planning Canada concept for two partners involved in a corporation.  He indicated that the CCRA would apply subsection 55(1) of the Income Tax Act4 (as it then read) to tax as a capital gain any tax-deferred intercorporate dividend where the parties were seeking to avoid tax on the unrealized gain on the shares of a taxable Canadian corporation.  In an attempt to remedy weaknesses in subsection 55(1), the Department of Finance (“the department”) codified the nucleus of Robertson’s comments with specific legislation that was enacted in 1981. The rules, under new subsection 55(2), allowed the intercorporate transfer of income on which tax had already been paid at the corporate level after 1971. This came to be known as “safe income.” The department also enacted two exceptions to the anti-avoidance rule in subsection 55(2) that would serve as the divisive reorganization provisions in the Act. The first exception, set out in paragraph 55(3)(a), applied in situations where the parties did not deal at arm’s length with each other. The second exception, in paragraph 55(3)(b), applied in situations where the parties involved in the transaction dealt at arm’s length with each other (“the butterfly” Over the next decade, the department became aware of additional abuses and losses of revenue at the corporate level. In particular, the department was concerned that resident and non-resident taxpayers were misusing the purchase butterfly to transform what would normally be a taxable sale of assets into an inter-corporate dividend.   The Basic Steps of the Butterfly Step 1: The shareholders of a distributing corporation (DC) will transfer a percentage of their common shares into a newly incorporated transferee corporation (TC) and take back common shares of the TC. Step 2: The DC will roll over the assets of the business it wishes to spin off into the TC and take back preferred shares of the TC. Step 3: The DC will repurchase for cancellation its common shares held by the TC and issue a promissory note as consideration to the TC. The TC will receive a deemed dividend and a deduction from part I tax. Step 4: The TC will redeem its preferred shares held by the DC and issue a promissory note as consideration. The DC will receive a deemed dividend and a deduction from part I tax. Step 5: The notes will be set off against each other in both the DC and the TC. Since they will be of equal fair market value (FMV), there should be no tax consequences to either the DC or the TC.  The original shareholders of the DC now hold shares in both the DC and the TC.[2]   Such a comprehensive corporate tax planning Canada require the assistance of qualified accountant experts as they prioritize the main purpose. The purpose of a spinoff butterfly is to move some property of a distributing corporation to one or more newly incorporated transferee corporations having the same shareholders in the same proportions as the distributing corporation. As a pre-distribution step in a typical spinoff butterfly, shareholders of the distributing corporation exchange their common shares in the distributing corporation for new common and preferred shares in the distributing corporation on a tax-deferred basis under subsection 51(1) or 86(1). Such an exchange is a "permitted exchange" under subsection 55(1), provided that it does not result in an acquisition of control of the distributing corporation. Thus, one presumes that the exchange is unobjectionable under the butterfly rules in section 55. However, the share exchange may technically infringe paragraph 55(3.1)(a). If that is the case, paragraph 55(3)(b) will not operate to prevent the application of subsection 55(2).     Get Access to leading accounting and tax expertise. Call Nicholas Kilpatrick at 604-327-9234.   Paragraph 55(3.1)(a) will cause paragraph 55(3)(b) not to apply where, in contemplation of and before a distribution made in the course of the reorganization in which the dividend was received, property became property of the distributing corporation otherwise than as a result of certain enumerated exceptions, none of which appears to apply to a share exchange. Thus, whether paragraph 55(3.1)(a) will apply to the share exchange turns on whether the old shares become property of the distributing corporation. The CRA has taken the position that a clearance certificate is required when a non-resident shareholder exchanges common shares in a corporation for preferred shares under subsection 51(1) The purpose of paragraph 55(3.1)(a) is to prevent property from being acquired by a distributing corporation before a butterfly in order to change the types of property owned by the distributing corporation that would permit the tax-free cashing out of a shareholder. The Department of Finance made a deliberate policy decision to exclude public corporations from the "types of property" requirement through the addition of subsection 55(3.02).  Amendments provide that paragraph 55(3.1)(a) does not apply to public corporations. Because the paragraph is concerned with the "types of property" requirement, the exclusion of public corporations from its application makes sense. In the private company context, the share exchange does not offend the policy at which paragraph 55(3.1)(a) is aimed, since it will not change the types of property that the distributing corporation holds. The share exchange is simply a necessary pre-distribution step to facilitate the paragraph 55(3)(b) butterfly. Nevertheless, owing to the current wording of paragraph 55(3.1)(a), the share exchange may technically trigger its application. Notwithstanding the analysis above, the CRA does not appear to consider a share exchange objectionable: it has issued favourable rulings in the when a share exchange took place as a pre-distribution step in a spinoff butterfly. Normally, when proposing to engage in butterfly transactions, comfort letters from the CAR are secured in order to have the benefit of the analysis from the CRA regarding such proposed transactions.  Although not binding, these comfort letters provide not only comfort to the client and the tax practitioner regarding the proposed series of events encapsulated as a part of the transaction, but also confidence to progress in the transaction. We at Burgess Kilpatrick, offer end-to-end assistance and understanding for such complex corporate tax return Vancouver concepts.   If you have any questions or want to speak further about your corporation or estate planning matters, contact Nicholas Kilpatrick at nkilpatrick@burgesskilpatrick.com   Nicholas Kilpatrick is a partner with the accounting firm of  Burgess Kilpatrick and specializes in tax structuring and business development for his small and medium business sized clients.  Please visit our website at www.burgesskilpatrick.com or on Facebook at www.facebook.com/Burgess Kilpatrick for more information on our firm.     [1] Haughey, Marshall, Spinoff Butterflies in Trouble?, Bennett Jones LLP. [2] Kakkar, Manu, A Critique of Canada’s Divisive Reorganization Rules: Should Breaking Up Be So Hard To Do?, Canadian Tax Foundation, Vol. 49 No. 4.

    Leading Tax Advice Call Nicholas Kilpatrick 604-612-8620     There has been a substantial increase by corporate and individual taxpayers alike in Canada of the use of Life Insurance products to facilitate the minimization of tax and effective transfer of wealth.  This article reviews 2 of the most effective uses of life insurance to transfer wealth to future generations:  

The Waterfall Concept

Also called the Cascading strategy, the Waterfall Concept is a strategy where a parent or grandparent uses a tax-exempt permanent life insurance policy to accumulate wealth tax-deferred, then transfers it to their child or grandchild as a gift without tax consequences to use throughout their lifetime. There are many variations of the  Waterfall Concept, so it can be tailored to meet an individual’s objectives. It is referred to as a “waterfall” because, like a waterfall, the transfer can flow downward only — i.e. for the gift not to be taxable, the life insured on the policy must be a child’s, and the policy must be transferred to a child. The provisions in subsection 148(8) of the Income Tax Act (ITA) govern the rollover. Under this subsection, a child is defined as the transferor’s child or grandchild, their son- or daughter-in-law, their spouse’s child from a previous marriage, their adopted child or their child from a common-law relationship. The term “child” is not restricted to a particular age, and the life insured and future policyowner don’t have to be the same child. In addition, the gift of the policy to the child must be made without consideration of any type. Many permanent life insurance policies have unique features and tax attributes that make them ideal vehicles to facilitate the transfer of wealth between generations. This insurance transfer strategy is popular because the transfers can be done in a tax-efficient manner without giving up control of the gift, and in most cases, without the assistance and cost of lawyers. Therefore, it can be rightly said that this particular corporate owned life insurance tax considerations are less complicated. How does it work? The transferor purchases a tax-exempt permanent life insurance policy on the life of a child and contributes to it, typically for three to five years. The policy grows on a tax deferred basis and is eventually transferred to the child of the transferor for no consideration. According to the provisions in subsection 148(8) of the ITA, the child becomes the new policyowner without any immediate tax consequences. However, any time the child withdraws funds from the policy, the funds are taxed in their hands — not the transferor’s — at their effective tax rate. The benefits of this strategy are that the child’s tax rate will most likely be much lower than the transferor’s, and taxes are deferred until the withdrawal actually occurs.   Dealing with potential issues The Waterfall Concept is very simple and becoming more popular given our aging population and the massive number of wealth transfers anticipated in the years ahead. However, there are a number of issues that should be considered when setting up this arrangement to ensure your client’s objectives are realized.   Death of the policyowner:  Whenever the policyowner is older than the life insured, there is a real possibility that the policyowner will pass away before the life insured. If this happens, the policy will become part of the deceased’s estate, and the gains in the policy will be taxable to the deceased. Probate fees may also apply. The larger the age difference between the policyowner and life insured, the greater the risk of this outcome.   Income attribution:  For the gift to be non-taxable, we rely on a rollover provision in the ITA. A rollover prevents tax from arising as a result of the transfer, but has no impact on the taxation of transactions that occur after the transfer. As such, if funds are removed from the policy in a situation where the income attribution rules apply, any taxes payable will be attributed back to the transferor. Loss of control over the policy:  The legal age to be able to negotiate a contract is 16 in all provinces except Quebec, where the age is 18. If the policy is transferred to a child under the legal age, the child does not have legal authority to deal with the policy until the child reaches the legal age to negotiate; thus, a court application for the appointment of a trustee will be required if a transaction needs to be executed. Control over the use of funds:  If structured right, the transferor can retain some control over the policy after it has been transferred to the child. Otherwise, the child gains control upon transfer. Most of these issues can be dealt with by utilizing the  features available in the insurance policy: The policyowner can name a child as the contingent owner: If a contingent owner is named, then upon the original policyowner’s death, the policy will be transferred to the contingent owner outside of the estate. Because the transfer is to a child and the life insured is also a child of the original owner, the rollover provisions apply. This strategy is particularly useful in cases where the transferor wants the gift to skip a generation. For example, if a grandparent acquires a policy on the life of a grandchild and names the child’s parent as the contingent owner, upon the grandparent’s death, the policy will roll over to the parent on a tax-free  basis, and the parent can then transfer the policy to the child at the appropriate time. This doesn’t eliminate the risk of the policyowner dying before the life insured, but it reduces it. Given that these policies are usually transferred shortly after the child reaches age 18, there is a very good chance that the parent will be alive at this time. The policy’s transfer can be deferred until the child  reaches age 18: This avoids concerns about income  attribution and loss of control. An irrevocable beneficiary can be placed on the policy prior to transferring it to the child: The irrevocable beneficiary must consent to policy withdrawals of any type before the child can access the accumulated value in the contract. The irrevocable beneficiary acts like a trustee to ensure the original owner’s wishes for the use of the funds are realized. The irrevocable beneficiary must be a trusted individual to ensure they allow the child to use the policy as originally intended.     Premium Accounting and Tax Assistance - call Nicholas Kilpatrick at 604-327-9234 to find out more for your business and click here to see our latest first-time offers.     What are the advantages of the Waterfall Concept?

• The transferor can provide a valuable gift and legacy for their child or grandchild.
• The transferor avoids annual taxation on the investment income generated on the gifted amount.
• They also avoid taxes when they transfer the funds to their child or grandchild. And when the child withdraws funds from the policy, as long as the transfer has been properly structured, the funds are taxable to the child, not the transferor, at the child’s tax rate.
• Probate fees can be avoided and the transferor’s privacy respected by ensuring the transfer doesn’t go through the estate.
• A trusted individual can control the use of the funds in the transferor’s absence.
• All this can be done through the life insurance contract, without the need for legal intervention.

It’s a gift a child or grandchild will never forget Passing on wealth using the Waterfall Concept enables grandparents or parents to give funds to a child to use for university, a wedding or any other important reason. They can give the child the right start and help them create a  valuable insurance policy, at very reasonable rates.  The child may also keep the policy in force if they want, avoiding possible insurability issues down the road.   Corporate-Owned Life Insurance Life insurance solutions available for corporate business owners are fundamental to protecting your family, business interest and continuity. Business owners have the option of owning life insurance policies personally or inside of their corporation. Corporate ownership has advantages and disadvantages, and deciding on where to own a life insurance policy involves serious consideration prior to making any decisions.[1] Funding a corporately owned policy Generally life insurance premiums are not tax deductible as the premium payment is not considered an outlay for the purpose of gaining or producing income from a business or property. Therefore the premiums will be paid with after-tax dollars so a business owner may want to utilize dollars that generate the least amount of taxes payable. There are three ways to fund a policy with corporate dollars:

The corporation pays a dividend to the business owner who then pays the premium and owns the policy personally.

The corporation pays an increased salary to the business owner who then pays the premium and owns the policy personally.

The corporation pays the premium directly and owns the policy.

From these three options usually the most tax-efficient strategy is to have the corporation pay the premiums directly and own it corporately. This is due to the fact that corporate tax rates are usually lower than individual tax rates. Furthermore this is a major factor in owning a life insurance policy corporately versus personally. One of the prime reasons why there has been substantial growth in corporate owned life insurance tax considerations.   Tax-exempt growth Corporately owned tax-exempt life insurance provides tax deferred growth, which is especially attractive for business owners who have maximized their total contribution room to their registered accounts. Specifically, the cash surrender value grows on a tax deferred basis in addition to a tax-free death benefit. This gives rise to a tax minimization strategy whereby a business owner reallocates funds, within the corporation, that would otherwise be subject to tax, into a corporately owned life insurance policy. Cash value options A corporately owned tax-exempt life insurance policy can provide more than a tax-free death benefit. In fact, during the life of the policy, the cash value can provide funds to the business owner for personal or business reasons. There are three options when accessing the cash surrender value:

Partial of full withdrawal of funds within the cash value account.

Obtain a policy loan against the cash value from the insurer.

Collaterally assign the policy to secure a loan.

With the first two strategies, there would be a deemed disposition that could result in a taxable policy gain. Collaterally assigning the policy to secure a bank loan is not considered a disposition and will not affect the policy’s ability to grow on a tax deferred basis. The bank loan can be structured in different ways including no repayment until death enabling more possible solutions for the business owner. Even while the loan is outstanding, the policy continues to grow on a tax deferred basis which could produce a higher return than the interest rate on the loan. For these reasons the most efficient manner to access cash values usually is to collaterally assign the policy to secure a loan. A potential downfall of cash value within a corporately owned policy is that it may not be fully creditor proof.   Death benefit and beneficiary designation A corporately owned policy should also have the corporation as the beneficiary. When a corporation receives the death benefit from a life insurance policy it will receive a credit to its capital dividend account (CDA) in the amount of the total proceeds of the policy less the adjusted cost basis. The CDA is a notional tax account that tracks tax-free surpluses accumulated inside the corporation. The corporation can then issue tax free capital dividends to the intended shareholders.   Other corporate considerations

• The cash surrender value of the life insurance policy shows up on the balance sheet of the corporation and in turn affects the value of the corporation.
• It is possible to transfer a policy from your personal ownership into your corporation. Care         should be taken to determine the effect of such a transaction, which is considered a disposition of the policy for tax purposes. A resulting gain in the transfer may create tax consequences.

    Both of these strategies utilizing life insurance provide for tax-free transfer of wealth.  Life Insurance, by virtue of the tax-free character of the payout, provides for a substantially greater rate of return on premiums paid than on other non-registered investments. Learn more about corporate owned life insurance tax considerations with us at Burgess Kilpatrick.   If you have any questions or want to speak further about your corporation or estate planning matters, contact Nicholas Kilpatrick at nkilpatrick@burgesskilpatrick.com   Nicholas Kilpatrick is a partner with the accounting firm of  Burgess Kilpatrick and specializes in tax structuring and business development for his small and medium business sized clients.  Please visit our website at www.burgesskilpatrick.com or on Facebook at www.facebook.com/Burgess Kilpatrick for more information on our firm.           [1] RBC Wealth Management; Understanding corporately owned life insurance.

    Leading Tax Advice Call Nicholas Kilpatrick 604-612-8620     Taxation of inter-corporate dividends has been expanded by amendments to Subsection 55(2) of the Income Tax Act first proposed in the 2015 Federal Budget. This article provides an introduction to the “Purpose” test which determines the applicability of ss. 55(2) to a transaction. What is Subsection 55(2)? Canadian corporations are taxed on capital gains but can receive certain inter-corporate dividends tax-free. To take advantage of this, corporations will enter into transactions where capital gains are converted into tax-free inter-corporate dividends. These transactions, which vary in complexity and as to how they are conducted, are known as capital gains strips. A simple example of capital gains stripping is as follows: HoldCo wishes to sell its ownership of its subsidiary SubCo to an arm’s length third party. This sale would create a taxable capital gain as the fair market value (“FMV”) of SubCo’s shares presently exceeds their adjusted cost base (“ACB”). Prior to the sale, HoldCo causes SubCo to pay it a tax-free inter-corporate dividend equal to the difference between the FMV and ACB. This decreases the FMV of SubCo allowing the shares to be sold without incurring a capital gain.   A dividend stripping anti-avoidance provision, ss. 55(2) is intended to remove the tax benefits of capital gains stripping. It applies where a corporation receives dividends from another Canadian corporation for one of the three purposes listed below. These inter-corporate dividends must be part of a transaction involving the disposal of shares to an arm’s length party. Subsection 55(2) recharacterizes these tax-free inter-corporate dividends as proceeds of disposition. Capitals gain tax is paid on proceeds of disposition, and thus there is no longer a tax benefit to capital gains stripping.   “Purpose” Test Inter-corporate dividends will incur taxation under ss. 55(2) if the transaction is conducted for one of the purposes delineated in the subsection. Prior to the 2015 Federal Budget, the only purpose contemplated in ss. 55(2) was the reduction of capital gains. Two new purposes were added following the Budget. The current ss. 55(2) is applicable to transactions where one of the purposes of the transaction is:

• A significant reduction in the capital gain on any share,
• A significant reduction of the FMV of any share, or
• A significant increase in the cost of property of the party receiving the dividend.

  The Canada Revenue Agency (“CRA”) has stated the threshold of “significant” found in all three purposes could be measured as an absolute dollar or percentage amount. Whether an intended reduction or increase is significant will be determined on the facts in each case This low threshold permits extends ss. 55(2) to transactions which may have other legitimate purposes. As a result, the taxpayer must prove, on a subjective basis, that none of the purposes of a transaction were those listed in ss. 55(2)     Act Now To Get Our Value Pricing Adjustment on Audit and Review Engagements For Your Business   Expanded Scope of SS. 55(2) The 2015 Federal Budget’s addition of two new purposes along with reducing the scope of ss. 55(2) exceptions for Part IV assessable dividends and related party transactions has increased the variety of transactions taxable under ss. 55(2). Taxpayers must be wary of the expanded ambit of this section, as the taxpayer in 101139810 Saskatchewan Ltd. v Queen (2017 TCC 3) found out. In this case, the application of ss. 55(2) led to possible triple taxation. The taxpayer, endeavouring to use his lifetime capital gains exemption, conducted a series of transactions. He split a corporation he owned into two new corporations and sold ownership of those new corporations to purchasers. The taxpayer recognized a capital gain himself, and ss. 55(2) applied to recharacterize the tax-free inter-corporate deemed dividends to all three corporations as taxable proceeds of disposition. The CRA ultimately chose only to apply ss. 55(2) to the new corporations, avoiding the possible triple taxation. Safe Income on Hand Exception Subsection 55(2) is intended to capture tax-avoidant taxpayers, accordingly amounts which have already been taxed are exempted from ss. 55(2). This exemption, found in paragraph 55(2.1)(c) of the Income Tax Act, is called the safe income on hand exception. Safe income on hand is the amount of after-tax income retained by a corporation which reasonably contributes to the capital gain. The 2015 amendments reduced the scope of the other exceptions to ss. 55(2) but the safe income on hand exception remained largely unchanged. These amendments have made the safe income on hand exception the primary tool for avoiding the application of ss. 55(2) where a transaction has one of the listed purposes. The 2015 amendments did include two important changes to the language and operation of ss. 55(2). The wording of paragraph 55(2.1)(c) was changed from income reasonably “attributable” to the capital gain to income which reasonably “contributes” to the capital gain. This change was meant to reflect the expanded purpose test. The second change was made to paragraph 55(5)(f) of the Income Tax Act, which operates in conjunction with ss. 55(2). Prior to the 2015 amendments, when a dividend was issued without sufficient safe income on hand to exempt the entirety of the dividend from ss. 55(2), the whole dividend would be taxed under ss. 55(2). In order to avoid this outcome, corporations would file a designation to split the dividend into smaller dividends. The smaller dividends isolated the amount which qualified for the safe income on hand exception from the excess amount of the dividend, preventing taxation of the entire dividend. Now, ss. 55(5)(f) applies automatically to divide a divided into the amount exempt as safe income on hand and the remaining amount which is taxed under ss. 55(2). The amendment to paragraph 55(5)(f) has made the safe income on hand simpler for taxpayers seeking to avoid recharacterization under ss. 55(2).   If you have any questions or want to speak further about your corporation or estate planning matters, contact Nicholas Kilpatrick at nkilpatrick@burgesskilpatrick.com   Nicholas Kilpatrick is a partner with the accounting firm of  Burgess Kilpatrick and specializes in tax structuring and business development for his small and medium business sized clients.  Please visit our website at www.burgesskilpatrick.com or on Facebook at www.facebook.com/Burgess Kilpatrick for more information on our firm.  

    Leading Tax Advice Call Nicholas Kilpatrick 604-612-8620   Amendments to section 55(2) of the Income Tax Act (IT) greatly broadened the reach of subsection 55(2) primarily due to the  addition of two new purpose tests and the restriction of the paragraph 55(3)(a) related party exception to only subsection 84(2) or (3) deemed dividends.  This article deals with the safe income exception in paragraph  55(2.1)(c) which is the only objective safe harbour in dealing with revised subsection 55(2).   [1] The Safe Income On Hand Exception The underlying concept of safe income is that once corporate income has been taxed, corporations should be able to pass that income amongst themselves on a tax‐deferred basis (subject to Part IV tax).  Accordingly, paragraph 55(2.1)(c) provides that a dividend is not subject to subsection 55(2) if the amount of the dividend does not exceed an amount that is:  

• the income earned or realized by any corporation, after 1971 and before the safe‐income  determination time (SIDT) for the series, and,
• that could reasonably be considered to contribute to the shareholder’s hypothetical capital gain  on the share from which the dividend is received, at the moment immediately before the  dividend.

  The first part, the “income earned or realized by any corporation …” is often referred to as “safe  income”, and this amount represents corporate income that has been subject to tax, modified by  adjustments in paragraphs 55(5)(b), (c) and (d). The second part, the amount of safe income that must reasonably be considered to contribute to a  hypothetical capital gain, is often referred to as the “safe income on hand” or “SIOH” – being the safe  income that needs to remain “on hand” in order to contribute to a gain.  Income earned or realized that  is no longer on hand to reasonably contribute to a hypothetical capital gain cannot protect a dividend  against subsection 55(2).   Whether a capital gain could reasonably be considered to be “attributable” to safe income is arguably substantially the same as whether an amount of safe income can reasonably “contribute” to a capital  gain.   Prior to the  amendments, paragraph 55(5)(f) allowed the filing of a designation to carve a single dividend into a  series of smaller dividends, in order to protect against subsection 55(2) re‐characterizing an entire  dividend if SIOH happens to be less than the total amount of the dividend. Due to the amendments, paragraph 55(5)(f) applies automatically to split a dividend that exceeds SIOH into two separate  dividends: a dividend equal to the amount of the SIOH, and another dividend equal to the remainder.  The former is protected by the safe income exception; the latter is subject to re‐characterization under  subsection 55(2) if one of the purpose tests in paragraph 55(2.1)(b) is met.    Relevant period for calculating safe income: when to begin and when to end     Starting point – acquisition date A gain on a share cannot arise before acquisition of the share, and only  corporate earnings that arise after the acquisition could reasonably be considered to contribute to the  shareholder’s hypothetical capital gain on the share. Because of this, safe income is generally  determined for a period that begins with the time of acquisition of the share, to the extent that  acquisition date is after 1971. Therefore, no safe income dividend can be paid immediately after an  acquisition even if SIOH was available immediately prior to the acquisition. Conceptually, any corporate  earnings that were on hand prior to acquisition should form part of the shareholder’s purchase price  and therefore adjusted cost base (ACB) of the share.   Starting point – tax‐deferred acquisition  There are a number of exceptions to the general rule discussed above; the most common being where a  share is acquired by the shareholder on a tax‐deferred share exchange. In a situation where a share is  acquired on a fully tax‐deferred share exchange (either under sections 51, 85, 85.1, 86 or 87), the SIOH  of the old share flows to the new share. This is a reasonable result since the entire accrued gain is  transferred to the new share, and accordingly the income earned or realized prior to the acquisition (to  the extent it reasonably contribute to a hypothetical capital gain of the old share at the time of the  exchange) should reasonably be considered to contribute to the hypothetical capital gain of the new  share immediately after the exchange. Of course, this also means that the amount of SIOH inherited can  never exceed the amount of hypothetical capital gain of the old share at the time of the exchange.  This concept applies similarly to share mergers and splits. Where a shareholder exchanges, on a fully  tax‐deferred basis, two classes of old shares for one new class, the SIOH of the two classes will flow  through to the one class.  Conversely, where a shareholder exchanges one class of old shares for two  classes of new shares, the SIOH of the old class flows to the two new classes, allocated pro rata based on  the relative amounts of the inherent gain of the two new classes at the time of the exchange.     Get Access to leading accounting and tax expertise. Call Nicholas Kilpatrick at 604-327-9234.     Ending point for calculation – safe income determination time  Paragraph 55(2.1)(c) specifies that the relevant period for computing SIOH ends before the “safe‐income  determination time for the transaction, event or series…”. The term safe‐income determination time  (SIDT) for a transaction or a series is defined under subsection 55(1), and it is generally the earlier of the  time that is   1) immediately before the earliest dividend paid as part of the series; and   2) immediately after the earliest of certain dispositions or increase in interests described in  subparagraphs 55(3)(a)(i) through (v) that resulted from the series.   The challenge of dealing with this definition in practice is its reference to a “series”. The concept of a  "series of transactions or events" has been defined very broadly by the courts, and this broad definition is further expanded by subsection 248(10). Under the common law, transactions can constitute a  “series” if the transactions are pre‐ordained in order to produce a given result, and there is no practical  likelihood that the pre‐planned events would not take place in the order ordained.  Subsection 248(10)  then expands the meaning to deem a series of transactions or events to include "any related  transactions or events completed in contemplation of the series". In interpreting subsection 248(10), the  Supreme Court of Canada in Canada Trustco stated that "in contemplation" is read not just in the sense  of actual knowledge but also in the broader sense of "because of" or "in relation to" the series, and it  can apply to events before or after.  Later, in Copthorne Holdings Ltd. v R, the Supreme Court of Canada  clarified that the "because of" or "in relation to" tests do not require a strong nexus, but requires more  than a "mere possibility" or a connection with "an extreme degree of remoteness".   The Court in Copthorne also confirmed that a subsection 248(10) series allows either a prospective or retrospective  connection of a transaction related to a common‐law series.  Given the expanded definition of “series” in subsection 248(10) and the broad interpretations by the  Courts, one must be cautious of historical events in computing SIOH. It should also be noted  that there is no minimum amount for an event to qualify as a triggering event for SIDT. A  taxpayer paying a significant inter‐corporate dividend believing itself to be entitled to a certain amount  of SIOH could be blind‐sided if it is unaware that an immaterial historical dividend or transaction  described in subparagraphs 55(3)(a)(i) through (v) was part of or resulted from the same series as the  dividend.  Once an event triggers a SIDT, any income earned or realized after the SIDT cannot be included  in SIOH.   The CRA announced in 2016 that it generally does not view regular, recurring  annual dividends to be part of a series of transactions.  As a result, the SIDT in respect of each of the  annual dividends occurs immediately before each such dividend, meaning that each dividend can take  into account the SIOH accumulated up to that point.     If you have any questions or want to speak further about your corporation, contact Nicholas Kilpatrick at nkilpatrick@burgesskilpatrick.com   Nicholas Kilpatrick is a partner with the accounting firm of  Burgess Kilpatrick and specializes in tax structuring and business development for his small and medium business sized clients.  Please visit our website at www.burgesskilpatrick.com or on Facebook at www.facebook.com/Burgess Kilpatrick for more information on our firm.  This article has been paraphrased from an article by Kenneth Keung of Moody’s Gardner Tax Law LLP.       [1] Kenneth Keung, CA TEP, Moody’s Gardner Tax Law LLP, Canadian Tax Foundation Prairies Conference.

    Leading Tax Advice Call Nicholas Kilpatrick 604-612-8620     The purpose of the replacement property rules in the Income Tax Act (ITA) is to allow a taxpayer to defer the recognition of a capital gain, recapture of capital cost allowance (CCA) or the gain on sale of eligible capital property (ECE) when property has been disposed of and it is replaced with the acquisition of similar property, provided that all the requirements of the ITA are met. The benefit of these rules is that there is no cash outflow needed to pay the related income taxes on these types of dispositions provided that the proceeds are being used to purchase a replacement property. The election is made by filing a letter with the tax return for the period in which the replacement property is acquired. [1] Overview: Generally, the Tax Act permits a taxpayer to elect to defer the recognition of income or capital gains where a property is disposed of and a "replacement property" is acquired within the prescribed time deadlines. To be considered a "replacement property", the following conditions must be met:

It must be reasonable to conclude that the property was acquired by the taxpayer to replace the former property. This means that there must be some correlation or direct substitution between the disposition of a former property and the acquisition of the new property.

In the case of ECE, it must be acquired by the taxpayer for a use that is the same or similar to the use to which the taxpayer put the former property. For depreciable and other capital property, the property can be acquired by the taxpayer or a related person.

In the case of ECE, it must be acquired for the purpose of gaining or producing income from the same or a similar business as that in which the former property was used. What this means is that you cannot use the replacement property rules to defer the income or gain on the sale of land and buildings by purchasing a manufacturing plant since they are not similar businesses.

In the view of the Canada Revenue Agency (CRA), the replacement property rules are not intended to apply to business expansions. It is a question of fact as to what is considered to be a business expansion.

As per the Replacement Property Rules, the types of property eligible and the deadlines that need to be met are as follows:

The replacement property must be acquired before the end of the first taxation year following the disposition.

Depreciable and other capital property - the type of property and the circumstances resulting in the disposition determines the type of property and the timing deadline.

In the case of an involuntary disposition the replacement property must be acquired before the end of the second taxation year following the disposition. The property included in this category includes all capital property (land, buildings and equipment). In the case of a voluntary disposition, the replacement property must be acquired before the end of the first taxation year following the disposition. The property included in this category includes only "former business property" which is defined to mean capital property of the taxpayer that is real property (land and buildings only) and does not include a rental property. In some cases where both land and building are disposed of and a capital gain remains on one even after the application of the above rules, it may be possible to reallocate proceeds of disposition between the land and building in order to reduce and even eliminate the capital gain remaining.     Act Now To Get Our Value Pricing Adjustment on Audit and Review Engagements For Your Business   According to Replacement Property Rules, all calculations are done on a property by property basis (for example, a separate calculation is done for each of land and building). Where the proceeds of disposition are all reinvested in the replacement property, the entire income and capital gains on the disposition can be deferred. The new capital cost of the replacement property is reduced by the amount of the deferred capital gains. As a result, when the replacement property is sold, the now lower capital cost is used in determining whether or not there are any capital gains to be realized. The amount eligible for capital cost allowance purposes is reduced by both the deferred capital gain and the deferred recapture. An election to defer recapture automatically means you are electing to defer the capital gain as well and vice versa. Where the replacement property is purchased in a subsequent year, a letter needs to be attached to the tax return for the year the replacement property is acquired to request the adjustment of the prior year return (to amend the income and capital gain otherwise required to be reported in the year of disposition).   If you have any questions or want to speak further about your corporation, contact Nicholas Kilpatrick at nkilpatrick@burgesskilpatrick.com   Nicholas Kilpatrick is a partner with the accounting firm of  Burgess Kilpatrick and specializes in tax structuring and business development for his small and medium business sized clients.  Please visit our website at www.burgesskilpatrick.com or on Facebook at www.facebook.com/Burgess Kilpatrick for more information on our firm.      [1] Replacement Property Rules, Baker Tilly.

    Leading Tax Advice Call Nicholas Kilpatrick 604-612-8620     If a taxpayer owns shares in a corporation that was built over the years and that now contains substantial value, he/she probably anticipates leaving this value to a future generation.  However, without a tax-planning strategy involving the wealth in the company, that wealth will be exposed to double taxation and that future generation will see much less of that wealth than if some time was taken to plan the taxpayer’s estate before death. Subsection 70(5) and the Potential for Double Tax When an individual dies and own shares in a private corporation, the shares are deemed to be disposed of at Fair Market Value (FMV)[1].  This deemed disposition can only be avoided when the shares can be rolled over to a spouse or a spousal trust.  Those shares are then deemed to be purchased by the deceased’s estate at a cost equal to the FMV.  However, the deemed disposition does not change the Adjusted Cost Base (ACB) of the assets in the corporation. Normally, the executor of an estate will wind up the company in order to accomplish distribution of estate proceeds.  Doing this, however, results in a deemed dividend under subsection 84(2) equal to the difference between the FMV and the Paid-up Capital (PUC) of the shares, thereby resulting in double taxation on the value of the corporation. For example, if Mr. X started a business and had 100 shares issued to him for $1 each, the paid up capital (PUC) of those shares is $100.  These constitute the total issued shares of the corporation.  Through the years he has grown the business and today the value of his shares is $1,000,000. Like What You're Reading? Read More at:     Upon the death of Mr. X, his shares are deemed to be sold for $1,000,000; 50% of this amount will be taxable.  Then when the executor winds-up the estate, there will be a deemed dividend on the estate equal to the same amount, as follows, Upon death Value at death $1,000,000 Less: PUC of shares -100 Capital Gain 999,900 Taxable capital gain (50%) 499,950 Tax (30%) - A 149,985 Upon wind-up of estate Deemed dividend under ss. 84(2) 999,900 Tax (35%) - B 349,965 Total tax paid (A + B) $499,950 Combined tax on sale 50.00%   Assumptions: Capital Gain tax = 30%; Deemed dividend tax = 35%   Techniques to Relieve Against Double Tax The two main techniques to relieve against this form of double taxation are:

• Capital loss carry-back under subsection 164(6) of the ITA, to create a loss in the deceased’s estate within the first tax year of the estate, which can be carried back to the final return of the deceased to offset the capital gain reported on that return.
• Pipeline Planning, in which a new corporation is used to convert that value in the corporation to debt so that the value can be extracted by the estate tax-free

 

Capital loss carry-back under subsection 164(6) of the ITA

For this technique to be executed correctly, the executor of the estate must be organized and begin administering the estate soon after the death of the taxpayer, because this provision is only available in the first year of the estate. This subsection of the ITA allows for the value of the deemed dividend triggered upon the wind-up of the corporation to be deducted from the value of the shares of the corporation.  Once the deemed dividend has been paid and all of the value of the corporation has been considered extracted as a result of that dividend, the value of the shares are nominal.  The ITA allows for the value of the deemed dividend to be deducted from the value of the shares at wind-up, thereby resulting in a loss which can be carried back to the final return of the taxpayer, as follows:   The taxpayers’ estate is established upon the death of the taxpayer and begins on the day after the taxpayer’s death.  An estate tax return must be filed by the end of the tax year (ie: the first tax year ends on the day that is the day before the same date of the year following the year of the taxpayers’ death), and this carry-back must be claimed in the form of an election on that first return. Tax planners should be consulted as soon after the death of the deceased as possible in order to determine materials needed to calculate the deemed disposition and subsequent capital loss to carry back.  All information and administration necessary to facilitate this carry-back can be time-consuming, and so it is best to begin this process early.     Premium Accounting and Tax Assistance - call Nicholas Kilpatrick at 604-327-9234 to find out more for your business and click here to see our latest first-time offers.   Some resources on this topic may reference a “Circularity” issue that prevents the execution of a loss carry-back in a situation like this.  This circularity issue is embedded within Section 40 of the ITA, which determines a taxpayers gain or loss from the disposition of property.   Specifically, subsections 40(3.4) and (3.6) defer a taxpayer’s loss where, despite a disposition by the taxpayer, the loss property remains within – or the property is acquired by – a person within the population of persons affiliated with the taxpayer. However, subsection 40(3.61) specifically ensures that these subsections will not apply to any portion of the capital loss carried back that is in excess of the capital gain claimed on the deceased’s final tax return. In the event that, from the time of the deceased’s death to the end of the first year of the estate, the value of the shares of the corporation have declined, the value of the capital loss carried back to the final return will be less than the capital gain reported on the final return.  However, additional planning can be executed to take advantage of any possible tax benefits inherent in notional accounts of the corporation such as the CDA, RDTOH, NRDTOH, or GRIP accounts to further reduce tax exposure. As you can tell, if we can carry back the capital loss on the first estate return to the final return of the deceased, then the only tax exposure remaining (assuming the capital loss is equal to the capital gain claimed on the final return of the deceased) is the dividend that was reported on the estate’s first tax return.  The second technique, if applied correctly, can further reduce tax exposure in this estate planning cycle to that of a capital gain.  This second technique is referred to as “Pipeline Planning”  as discussed below:

Pipeline Planning

The Pipeline plan simply involves incorporating a new company which, through a series of transactions, will convert the increase in value in the shares of the corporation from a capital gain to a loan receivable to the estate.  To create a Pipeline, assume that the taxpayer, Mr. X owns XCo:  

• X’s estate incorporates a new corporation, Newco, for nominal consideration.

 

• The estate sells the shares of XCo to Newco for $1,000,000 (assuming no accrued gain or loss on the shares since Mr. X’s death)

 

• The sale proceeds payable by Newco would be a non-interest bearing demand promissory note payable by Newco in the amount of $1,000,000

 

• XCo would be wound up into Newco on a tax-deferred basis.

 

• Newco would use cash on hand (ie the cash that was in XCo) to repay the loan to the estate.

  By using this method, what was as deemed dividend under the carry-back method is no a loan that has been repaid tax-free, resulting in the shares having only a capital gain exposure.   One of the concerns that has for a long time prevented the application of the Pipeline method in some estate plans is the possibility of the Canada Revenue Agency (CRA) assessing a deemed dividend under subsection 84(2)of the ITA on the sale of the shares to Newco for $1,000,000.  Section 84 (paraphrased) is a deemed dividend provision of the ITA which, when certain fact patterns exist, assesses distributions from corporations to non-arms length individuals as deemed dividends.  However, there have been many cases in which the CRA ruled favourably in prior advance rulings on the non-application of subsection 84(2), when the following applied:  

That the corporation in question (ie: XCo in our example) would remain a separate and distinct entity for at least one year.

That during this one year period, the corporation would continue to carry on its business in the same manner as before, and

Only thereafter would the note be repaid on a progressive basis.

  One point to consider is that, when the above points exist, subsection 84(2) should not apply to the transaction because the money is being paid to cancel a debt (ie: the $1,000,000 loan) rather then being paid for the benefit of shareholders, and the continuance of the operation of the business further qualifies the loan as an operating one, the repayment of which benefits the corporation and contributes to it’s working capital resources.   In summary, the Pipeline plan, if executed correctly and if sufficient planning is done, results in the lowest tax exposure (ie: capital gain).  This plan also involves the most time and financial resources to correctly implement.  Consideration should be given to the costs versus the ta benefits of implementing such a plan. The carry-back plan, by contrast, is easier to implement, but results in tax exposure equal to that paid on the deemed dividend reported on the estate’s first tax return.  Organization and proactive administration of the estate is necessary to ensure that the carry-back can be effected in the first year of the estate’s tax filing.  Note that the deadline to filing an estate’s T3 tax return is 90 after the end of the tax year of the estate.  Either method, however, is preferred to the onerous tax consequences realized if no planning is done at all.   If you have any questions or want to speak further about your corporation or estate planning matters, contact Nicholas Kilpatrick at nkilpatrick@burgesskilpatrick.com   Nicholas Kilpatrick is a partner with the accounting firm of  Burgess Kilpatrick and specializes in tax structuring and business development for his small and medium business sized clients.  Please visit our website at www.burgesskilpatrick.com or on Facebook at www.facebook.com/Burgess Kilpatrick for more information on our firm.     [1] Falk, Chris; Morand, Stefanie, “Income Tax Developments in Estate Planning and Administration”, Law Society of Upper Canada 15th Annual Estates and Trusts Summit

    Leading Tax Advice Call Nicholas Kilpatrick 604-612-8620     When a Canadian corporation holds a controlling interest in a foreign affiliate, that affiliate can generate 2 types of income for the Canadian parent:

Active Business Income (ABI), or

Foreign Accrued Property Income (FAPI)

Whereas the first type of income is self-explanatory, the second type of income is defined in subsection 95(1) of the ITA; it is more generally described as passive income and includes income from property, rent, royalties, investment income, and taxable capital gains from the disposition of property that is not used in an active business. Although some controlled foreign affiliate (CFA) businesses are investment businesses, generally those property businesses will be considered for Income Tax Act (ITA) purposes to generate ABI if those employed by the CFA cumulatively comprise work at least 5 full-time equivalent (FTE) hours. There are even some types of income that are specifically excluded from FAPI, such as taxable dividends paid from foreign affiliates generating ABI.  Such dividends paid to the Canadian corporation owning the shares of the foreign affiliate are deductible under section 112 of the ITA and therefore not taxable.  The overall objective of the FAPI rules is to ensure that Canadian corporations pay tax annually on income from investments that are located in an off-shore jurisdiction but that remain under the control of the Canadian corporation. The concept of FAPI is that Canadian-resident taxpayers could without these rules earn passive income in foreign subsidiaries and keep it there until the money was needed back in Canada, if ever.  Unless the money is repatriated back to Canada, Canadian taxes on the income would be deferred indefinitely.  Prior to the introduction of the FAPI rules in the ITA, a common strategy to realize this tax deferral was to utilities an offshore holding company to hold passive investments.  The application of FAPI is intended to eliminate this otherwise Canadian tax deferral The FAPI rules instead deem all passive income generated by the CFA, whether that income is actually received by the Canadian parent or not (hence the word “accrued” in the full terminology), to be included in the income of the Canadian parent in proportion to the ownership percentage that the parent holds in the CFA.  Specifically, under section 91 of the ITA, the amount of FAPI generated by a CFA that must be reported by a Canadian parent is equal to that parent’s participating percentage in that CFA.  For example, if the Canadian parent owns 75% of the outstanding shares of the CFA, then 75% of the FAPI generated by the CFA in a year must be reported as income on the Canadian parent’s tax return. In calculating the proportionate percentage of net income that must be included in the  parent’s income, the following amounts can be deducted from gross income calculated from the CFA:

• Losses from property
• Losses from a business other than an active business
• Certain allowable capital losses from the disposition of certain property.

If the deduction of these losses exceeds FAPI of the Canadian parent, the resulting “foreign accrual property loss” can be carried forward 20 years and carried back 3 year and applied against FAPI incurred in those years.     Get Access to leading accounting and tax expertise. Call Nicholas Kilpatrick at 604-327-9234.   In addition, a reduction of taxes is allowed to take into account any foreign taxes paid on the FAPI.  This reduction, similar to a foreign tax credit on the personal tax returns of Canadian taxpayer’s, is calculated by multiplying the “foreign accrued tax” by the “relevant tax factor (FAT)”, or put simply:   foreign accrual tax (FAT) applicable to FAPI X the Canadian parent’s “relevant tax factor (RTF)   The RTF is calculated by dividing 1 by the tax rate of the CFA, or [1 / .25] when using the default withholding tax rate.  Bypassing complicated calculations, the RTF of a corporation is therefore 4.  When multiplying the RTF by the FAT, the product of the equation is designed – in theory – to simulate the Canadian dollar equivalent of the foreign taxes paid on the FAPI. By contrast, if the FAPI income is held by a Canadian resident individual, the RTF is 2.2.  Due to the higher RTF of Canadian corporations, effective tax planning and reduced tax exposure can be realized by executing a reorganization under subsection 85(1) to have the property generating FAPI transferred from a Canadian resident individual to a Canadian resident corporation to take advantage of the higher RTF available to the corporation and, consequently, lower Canadian tax exposure. The higher RTF of a corporation results in a possibly substantial tax deferral on FAPI.  However, utilizing a corporation with FAPI can also result in an absolute savings in tax.  If the FAPI is paid to the corporation as a dividend, it passes through the corporation free of Canadian tax (due to a full deduction of the dividend under paragraph 113(1)(b), and out to the individual shareholder as an eligible dividend.  Since the tax owing on this type of dividend is less than the tax that the taxpayer would have to pay on a non-eligible dividend, using a corporation to receive the FAPI results in less tax paid.   In summary, the net FAPI income that is taxable to the Canadian parent is calculated as follows:

• Starting FAPI recognized by the Canadian parent (participating percentage basis),

Less

• Applicable deductions from FAPI

less

• Foreign tax credit

= income inclusion to the Canadian parent.   The net amount of FAPI included in the Canadian parent’s income is then added to the adjusted cost base (ACB) of the shares it holds in the CFA.   The remaining amount of Canadian tax paid on the net FAPI, after subtracting the foreign tax credit, brings the cumulative tax paid on the FAPI to an amount equal to the amount of tax paid had the income been generated in Canada.  This is the intent of the tax parity intention of the Income Tax Act, which is to simply facilitate the consistent computation of Canadian tax owing, regardless of the source of that income.   If you have any questions or want to speak further about your corporation or estate planning matters, contact Nicholas Kilpatrick at nkilpatrick@burgesskilpatrick.com   Nicholas Kilpatrick is a partner with the accounting firm of  Burgess Kilpatrick and specializes in tax structuring and business development for his small and medium business sized clients.  Please visit our website at www.burgesskilpatrick.com or on Facebook at www.facebook.com/Burgess Kilpatrick for more information on our firm.

      Leading Tax Advice Call Nicholas Kilpatrick 604-612-8620   An estate freeze is a technique used to freeze the value of someone’s business interest, pass the future growth in that business to someone else, and yet still control the business.  This article discusses some of the different types of corporate freeze strategies, and some reasons for doing – and not doing – a freeze.[1]   How an estate freeze works: the section 86 reorganization There are many ways to do an estate freeze, and the most common way is the section 86 freeze.  Named after the section of the Income Tax Act that governs it, the section 86 reorganization is an exchange of shares or reorganization of capital. In a typical estate freeze, a business owner owns all the shares in the incorporated business. Usually those shares are common shares with voting rights. The owner identifies a successor or successors for the business. Often the successors are the owner’s child or children, or a key employee or group of key employees. The owner has the company redeem the owner’s shares. In exchange the company issues new preferred shares with voting rights to the owner. The preferred shares have a fixed redemption value and are equal in value to the common shares just redeemed. As such, no immediate capital gains tax consequences result from this share exchange. The owner could redeem the preferred shares at any time, but only for their fixed value. Any capital gains tax consequences would be realized at that point. At the same time, the company issues new common shares to the successors. Since the preferred shares represent all the company’s value to that point, the new common shares have no value. However, any future growth in the company’s value would accrue to the common shares, not to the preferred shares. The common shares would also have voting rights, but not enough to outvote the preferred shares even if a substantial number of preferred shares were redeemed. So no matter how large the company grew, the preferred shareholder would remain in control of the company until almost all of the preferred shares were redeemed.   An example may help to show how a preferred shareholder could maintain control of the company even while the company redeemed the preferred shares. The company’s owner could transfer all the common shares in the company for 1,000 preferred shares. Each preferred share would have 1,000 votes (1 million votes in total). At the same time, they would have the company issue 1,000 common shares to the successors. Each common share would have 1 vote. Under this arrangement, the preferred shareholder could redeem all but two preferred shares and still have enough votes to control the company. The owner could elect to treat the redemption of the common shares as a distribution of those shares. The owner could choose a price between the shares’ adjusted cost base and their fair market value. If the company had grown in value from when the owner started it, a distribution would trigger capital gains tax. However, if the owner had some or all of the lifetime capital gains exemption available, and if the business qualified for the exemption, the exemption could be used to reduce or eliminate the capital gains tax that would result. An owner considering this option needs to consider whether there will be any issues with the cumulative net investment losses account, allowable business investment losses, or with alternative minimum tax.  Regardless of whether the owner uses the capital gains exemption, the amount the successors will one day need to pay for control of the company will be frozen, and the owner’s probate tax liability for the business will also be frozen.   Variations on an estate freeze: the section 85 share exchange and a trust A section 85 share exchange is a slightly different type of estate freeze, again named for the section of the Income Tax Act that governs it. Rather than have the company redeem shares, the owner creates a holding company, and transfers the common shares to the newly created holding company. The holding company then issues preferred voting shares (in the holding company) to the owner. The holding company also issues new common shares to the owner’s successors. Similar to the section 86 reorganization, the superior voting power of the new holding company preferred shares allows the owner to control the holding company even though the new common shares also vote. Since the holding company owns all the shares in the operating company, the owner also controls that company, too. An owner can also do an estate freeze by transferring the common shares to a trust. This type of freeze is often used when the intended successors are children too young to own shares. One advantage to the trust is that it can give the owner and the owner’s family some flexibility. If the children decide to not participate in the business the trustees could sell the business to a third party. Or, if the owner died prematurely, the trustees could manage the business for the children until they were old enough to run it themselves, or could manage the business for the owner’s spouse until a buyer for the business could be found. Also the owner could structure the trust to reverse the freeze if circumstances changed (although the tax benefits from the estate freeze would not work as well). Another advantage to moving the business into a trust for the children is that the trust assets can be protected from claims of the children’s creditors or from inclusion in their net family property if their marriages fail. There are some drawbacks to using a trust, though. Any property transferred to the trust is subject to capital gains tax. Trust income that is not distributed is taxed at the highest marginal rate without personal tax credits. A trust is also subject to a deemed disposition of its assets every twenty-one years, with the potential for capital gains tax consequences.   Partial estate freezes An owner doesn’t have to freeze all of the shares at once. An owner can freeze only some of the company’s shares, with the option to freeze the rest at a later date. This is a way to achieve some of the aims of a full estate freeze already discussed, but still retain some right to participate in the company’s future growth. A partial estate freeze may be appropriate if the owner is too far from retirement to do a full estate freeze, but needs to transfer   Reductions to the Capital Gains Exemption If you borrowed money to acquire shares in a company, the cumulative net investment loss (CNIL) account tracks the deductible loan interest that you paid to acquire those shares minus the net income you received from the shares (such as dividends). If, when you sell the shares, you want to shelter capital gains from tax by using the lifetime capital gains exemption, the exemption will be reduced by any amount in your CNIL account. Also, allowable business investment losses can be deducted from ordinary income. However, to the extent that you deduct such losses against income, you will not be able to use the lifetime capital gains exemption to shelter capital gains from tax. The alternative minimum tax (AMT) is a parallel tax regime imposed on high income earners. Without the AMT, such individuals could use tax breaks available to them under the normal tax system to pay very little tax or no tax at all. The AMT requires them to also perform a separate tax calculation and pay the higher of the two tax bills. AMT can produce an unpleasant surprise for someone selling capital assets. For example, if your only income for the year is the capital gain, and if you anticipate using the lifetime capital gains exemption to completely eliminate your tax liability, the AMT tax calculation may still require you to pay some tax.  This tax, however, will be refundable if in future years your reported income results in a tax liability.  That liability will be reduced by the amount of the “prepaid” AMT.       Act Now To Get Our Value Pricing Adjustment on Audit and Review Engagements For Your Business   A couple of ways not to do an estate freeze The complexities of share redemptions, holding companies or trusts may make some wish for a simpler alternative. Unfortunately, the drawbacks from the simpler alternatives may outweigh any benefits they offer. One alternative is for an owner to simply give or sell the shares to the successors. Unfortunately, the owner would then lose control of the company, and could lose the right to continue working there. Capital gains tax would be due immediately. The new owners could even sell the company to third parties, defeating one of the main reasons for doing an estate freeze in the first place (which is the business continuity within the family or key employees). One partial solution to this problem is to sell the company to its new owners, taking a promissory note in exchange, rather than giving the company away or selling it for cash. The owner could then maintain control through the ability to call the loan. As a form of control, however, threatening to call a loan leaves much to be desired. An owner could not exercise that right except in the most serious circumstances. And as the company grows and the business becomes more valuable, the new owners could pledge their shares as collateral for a loan of their own, and repay the promissory note. Maintaining control through superior voting power, offered through a section 85 share exchange or section 86 reorganization, or through a trust, is a better alternative because it relies on the owner having the legal right to control the company, rather than on a threat to call a promissory note.   Reasons for doing an estate freeze Several reasons for doing an estate freeze have already been discussed. This section will examine these and other reasons in detail.

• Lock in capital gains and probate tax liabilities: By freezing the value of the business, the owner also freezes the capital gain and the amount that an executor will have to include as an asset for probate tax purposes. The owner will be in a better position to plan for these expenses, knowing that they will not grow.
• Lock in a purchase price for the business: By freezing the value of the business, the owner also sets the price that the future owners will have to pay for the business. The future owners will therefore be able to plan for the day when they will own the business themselves, and will be better able to complete the purchase.
• Secure a commitment to the business from its future owners: Since the successors will own any increase in value that the business experiences, they will have an incentive to work hard to preserve and increase that value. And as the value of their interest in the business grows, so does their incentive to remain with the business. The business becomes too large an asset to walk away from.
• Encourage a smooth transition: by locking in the price and securing a commitment to the business’ long term future, an owner using an estate freeze helps ensure a smooth ownership transition.
• Transfer risk to future owners: since the successors will have common shares, they will have greater risk if the company goes under than the owner, who will have preferred shares. On liquidation, the preferred shareholders’ claims to the company’s assets are satisfied before the common shareholders’ claims.
• Provide retirement income: an owner could transfer preferred shares over time to the successors. This strategy could allow the successors to buy the owner out over time, and provide the owner with a retirement income. Further, if the owner’s preferred shares had enough votes, the owner could retain control of the company until almost all of the preferred shares were gone.
• Income splitting: an owner can split income with the children as the result of an estate freeze without violating the attribution rules. If the children are minors, trust income (if the estate freeze is done using a trust), dividend income and shareholder benefits will be subject to the attribution rules, but not business income or capital gains. Once the children become adults, many of the attribution rules cease to apply. Avoid family conflicts: in many families, some children will want to pursue a career in the family business, but others won’t. However, the family business is usually the parents’ major asset. By implementing an estate freeze, the parents can give the business to the children who one day will take over, and make plans to ensure that the children who won’t get the business are still treated fairly. Life insurance can help make that happen.
• Creditor protection: if the freeze is done using a trust or holding company, creditor protection can be enhanced.

  Reasons to not do an estate freeze Of course, there are also reasons to not do an estate freeze. One of the biggest has to do with timing. Generally, an estate freeze appeals to a business owner for whom retirement is on the horizon even if it’s not yet imminent. Such an owner may have children or key employees who are obvious natural successors. A younger owner’s children or key employees may not yet be ready. Another reason for not doing an estate freeze concerns the business’ potential. For example, if a business is on the cusp of becoming a multi-billion dollar enterprise, its potential is worth too much to just give away. This is especially true when you consider that an estate freeze is generally irrevocable or, at least, potentially very expensive to unwind from a tax perspective. Melts, thaws and refreezes Melts, thaws and refreezes are ways of unwinding an estate freeze.

• Melt: after completing an estate freeze, the owner redeems shares over time in a controlled distribution. The usual purpose for the melt is to provide a retirement income for the owner from the gradual redemption of the owner’s shares. The successors retain their shares. Ultimately, all the owner’s shares are redeemed, leaving the successors in control of the business. This type of freeze is also called a “wasting freeze” (not in the sense that the owner’s shares are wasted, but in the sense that they dwindle away over time as they are redeemed).

 

• Thaw: although an estate freeze is generally regarded as irrevocable, there are ways to thaw a freeze. If the owner has used a trust to freeze his or her estate, there may be provisions created to allow the business to revert to the owner. The price for such a provision would be a reduction in the tax advantages that would otherwise accrue to the owner after an estate freeze.

 

• Refreeze: if the value of a business has declined after an estate freeze, as it could during a recession, the owner and successors could thaw the estate freeze, even if they did not use a trust to accomplish the freeze. Generally, the irrevocable nature of an estate freeze comes from the unacceptable tax consequences that would follow strong business growth. But those consequences may be minor or nonexistent if the business has declined in value since the estate freeze. Having thawed the freeze, the owner could then refreeze the business, using the lower value that would prevail during a recession. Any capital gains exposure would then be based on the new, lower value for the business.

  These are just some of the aspects and issues surrounding corporate estate freezes.  If you have any questions or want to speak further about your corporation, contact Nicholas Kilpatrick at nkilpatrick@burgesskilpatrick.com   Nicholas Kilpatrick is a partner with the accounting firm of Burgess Kilpatrick and specializes in tax structuring and business development for his small and medium business sized clients.  Please visit our website at www.burgesskilpatrick.com or on Facebook at www.facebook.com/Burgess Kilpatrick for more information on our firm.  This article has been paraphrased from an article by Sun Life Financial titled ‘Estate Freezes: recognizing the opportunity. [1] Estate Freezes: Recognizing the Opportunity; Sun Life Financial.

    Leading Tax Advice Call Nicholas Kilpatrick 604-612-8620   Income splitting has become a very popular technique used by many individuals for effective income tax planning. The concept is simple: shift the income from one family member who is subject to a high rate of tax to another family member who is subject to a lower rate of tax. The end result is overall reduced taxes. But, though the concept may be simple, the strategies to implement income splitting can be extremely complex. The decision of the Supreme Court of Canada in the case of n B. Lipson, Earl Lipson v. The Queen on January 8, 2009 is a prime example of a complex income splitting strategy that was successfully challenged by the CRA. You can read more about this case in the winter 2009 issue of Tax Alert. [1] The Income Tax Act does permit certain income splitting arrangements, but there are still many arrangements that are considered improper and subject to the attribution rules, which are designed to reduce or eliminate the income splitting benefit. Section 74.4 of the Act contains an attribution rule commonly referred to as "corporate attribution." Corporate attribution applies when an individual tries to split income with family members by transferring or lending property to a corporation in order to benefit those specific family members while reducing the transferor's income. Consider this example: John has $500,000 of investments producing $25,000 of additional income that will be taxed at the high marginal tax rate due to John's current salary level. If John sets up a company with his family members (spouse and minor children) as shareholders, and then transfers the $500,000 of investments to the company in an attempt to divert this income to his family members indirectly through the company, corporate attribution would apply. Corporate attribution effectively reduces or eliminates the income splitting benefit by attaching a deemed interest rate to the consideration received on the transfer, thereby requiring the transferor to include into income a deemed taxable benefit. This taxable benefit is punitive because it results in taxable income to the transferor with no corresponding deduction to the company. Nor does it improve the transferor's ability to increase his or her shareholder's loan. Corporate attribution applies if the following two conditions are present

property was transferred or loaned to a corporation, and

the main purpose of the transfer or loan may reasonably be considered to reduce the income of the transferor and to benefit a designated person (spouse or minor child under 18 years of age).

The two conditions above are usually key ingredients in most income splitting strategies. Consequently, corporate attribution occurs frequently with many reorganizations and transactions, and it can catch the unwary taxpayer.   Common corporate attribution situations Corporate attribution applies in some of the most common corporate reorganizations, such as:

Estate freezes - An individual freezes the value of the company into fixed value preferred shares, thus allowing his or her spouse or minor children to own common shares directly or indirectly through a family trust. In either situation, an exchange of shares is considered to be a transfer of property to the corporation.

Creditor protection - A corporation operating a business that has certain elements of risk may consider a creditor protection corporate reorganization. This would involve setting up a holding company and transferring the corporation's redundant assets or retained earnings to the holding company. Corporate attribution might apply if the shareholders of the holding company are "designated persons."  A designated person is defined as a person who is the spouse or common-law partner of the individual or a person who is under 18 years of age and who does not deal at arm's length with the individual or is the niece or nephew of the individual.

Income Splitting - Corporations that only have one shareholder will usually freeze the value of the company in order to introduce family members as shareholders for the purpose of sharing dividends to reduce personal income taxes. This reorganization is usually carried out in the same manner as the estate freeze above, which may lead to corporate attribution if the family members are designated persons.

Bonuses and dividends - Bonuses and dividends occur not as part of a reorganization, but as a normal part of a profitable business. One would not think that a normal bonus or dividend could result in corporate attribution because there is no property being transferred to the corporation. But consider this common scenario: a bonus or dividend is declared, appropriate withholding taxes are paid, and a journal entry is posted to the individual shareholder's account to record his or her entitlement to the cash. The journal entry to post the bonus or dividend is simply the shortcut approach to actually providing the shareholder with the money, and the shareholder loaning it back to the company. In this situation, corporate attribution may apply because the loan is considered a transfer of property to a corporation.

    Premium Accounting and Tax Assistance - call Nicholas Kilpatrick at 604-327-9234 to find out more for your business and click here to see our latest first-time offers.     Corporate attribution tips Clearly, there are some common situations that can result in the application of corporate attribution. How can the impact of corporate attribution be minimized or avoided? Here are some tips:

• • Do not transfer or loan property. In an estate freeze of a company, consider a stock dividend instead. A stock dividend is not considered a transfer of property and is thus not subject to corporate attribution.
  • If a transfer or loan of property is required, ensure that it is not made for the main purpose of reducing the individual's income and/or benefiting a designated person. Consider the example where two spouses hold equal interests in a company, and they equally exchange their shares for fixed value preferred shares to accomplish an estate freeze in favor of their adult children. Each spouse would be considered a designated person but, since they have equal interests in the company, we can conclude that neither spouse is attempting to reduce his or her income to benefit the other.
  • If a transfer or loan is required and one of the main purposes of the transfer or loan is to reduce the income of the individual, ensure that a designated person is not involved in the transaction. Consider a spouse who is the sole shareholder of a holding company, and exchanges her common shares for preferred shares to affect an estate freeze. As long as the transaction does not include a designated person (spouse, minor children or minor nieces or nephews), corporate attribution would not apply.

It is easy to write about what not to do in a reorganization to ensure that corporate attribution does not apply, but actually implementing a reorganization is not always that easy. Sometimes, the objectives to be accomplished do not permit the avoidance of corporate attribution. In such cases, there are two exemptions that can be applied to avoid or minimize the deemed interest benefit that will result from corporate attribution. They are:

maintaining the small business corporation (SBC) status; and

paying out the prescribed rate on the consideration received for the transferred or lent property.

Maintaining the SBC status when corporate attribution applies is particularly important. This status requires the corporation to be a Canadian Controlled Private Corporation where 90% of the fair market value of the assets is used in an active business carried on primarily in Canada. As long as the corporation remains an SBC, corporate attribution will not apply. The SBC status is a "point in time" test; if at any point in time the company temporarily losses its status, corporate attribution will apply for that time period. Therefore, the corporation should monitor on a continuous basis to ensure that the SBC status continues to apply. There are many situations that can arise to cause a company to go offside on its SBC status, including, among others, retaining cash to pay a bonus, investing in non-active assets, and operating a profitable foreign branch or subsidiary. If corporate attribution applies, and the company cannot maintain its SBC status, the company may pay a rate of return on the consideration received for the transferred property. If property was transferred to the company in exchange for a note payable or share capital, interest could be paid on the note or dividends could be paid on the shares. The amount paid to the transferor will reduce the deemed benefit, with the entire benefit being eliminated when the amount paid equals the calculated benefit amount. If you have any questions or want to speak further about your corporation, contact Nicholas Kilpatrick at nkilpatrick@burgesskilpatrick.com   Nicholas Kilpatrick is a partner with the accounting firm of Burgess Kilpatrick and specializes in tax structuring and business development for his small and medium business sized clients.  Please visit our website at www.burgesskilpatrick.com or on Facebook at www.facebook.com/Burgess Kilpatrick for more information on our firm.  This article has been paraphrased from an article by John Oakey of Collins Barrow, Halifax, NS       [1] Oakey, John, Collins Barrow, Halifax, NS

    Leading Tax Advice Call Nicholas Kilpatrick 604-612-8620     In part 1 of our article on taxation of non-resident Canadian income, we dealt with the various filing requirements non-residents must complete on a yearly basis in relation to their Canadian sourced income.  This income includes, but is not limited to, Canada Pension Plan benefits, Old Age Security benefits, super-annuations, investment income generated from Canadian resident entities. In part 2 of our summary on the taxation of Canadian income earned by non-residents of Canada, we deal with income generated from taxable capital property situated in Canada.  Taxable capital property includes the sale of any real, depreciable or other immovable property, and the reporting requirement of any capital gain or loss arising from the sale of such property is captured in section 116 of the Income Tax Act (ITA). If a non-resident holds any interest in taxable Canadian property and wants to sell that property, there is a specific process that must be adhered to in order to correctly satisfy all legislative and Canadian income tax requirements prevailing upon such an anticipated transaction. As mentioned in part 1, unless an alternative tax rate is specified in a tax treaty or Information Exchange Agreement (IAE) between Canada and another country, a standard withholding tax rate of 25% is levied on the realization of any Canadian-sourced income or capital gains by non-resident individuals.  When a non-resident partially or completely owns taxable Canadian property and wishes to sell that property, that non-resident, normally with the assistance of a lawyer and/or accountant, needs to undertake a specific process in order to satisfy the previously mentioned legislative and Canadian income tax requirements.  An explanation of that process is the purpose of this article.   Receiving Approval For The Sale – The Certificate of Compliance For purposes of this article, we will assume that a non-resident of Canada living in the United States is the 100% owner of a rental property in Canada, and wishes to sell it.  He has secured an agreement with another individual for that other individual to purchase the property.     Get Access to leading accounting and tax expertise. Call Nicholas Kilpatrick at 604-327-9234.   If the sale completes, the lawyer for the non-resident will be required to remit tax equal to 15% of the proceeds of the sale (the tax treaty between Canada and the U.S.A applies a non-resident tax rate of 15% between the 2 countries, overriding the ITA-imposed rate of 25%).  Such a high tax rate is onerous and will ultimately result in a substantial refund on the U.S resident tax return of the Canadian non-resident once he reports the transaction. However, by securing a Form T2068, Certificate – The Disposition of Property by a Non-Resident of Canada (commonly referred to as a Certificate of Compliance) from the CRA on the transaction, the withholding tax to be remitted by the non-resident will be reduced to 25% of the anticipated capital gain on the sale. Application for a Clearance Certificate is executed by completing on or more of the following forms:

 T2062 – Request by a Non-Resident of Canada for a Certificate of Compliance Related to the Disposition of Taxable Canadian Property.

2. T2062A - Request by a Non-Resident of Canada for a Certificate of Compliance Related to the Disposition of Canadian Resource and Timber Resource Property, Canadian Real Property (other than Capital Property) or Depreciable Taxable Canadian Property. 3. T2062B- Notice of Disposition of a Life Insurance Policy in Canada by a Non-Resident of Canada.                                               ,   We will not be dealing here with the circumstances surrounding the submission or T2062B. Where the non-resident is disposing of depreciable property, both forms T2062 and T2062A must be submitted in the same application package. The T2062 series of forms essentially provides for a description of the property being sold and the particular contact information of the non-resident vendor. The non-resident vendor must have an Individual Tax Number (ITN).  While the Social Insurance Number can be used by Canadians owning Canadian property who have moved outside of Canada and who wish to sell that property, other individuals who do not have a Social Insurance Number can use for T1261 - Application for a Canada Revenue Agency Individual Tax Number (ITN) for Non-Residents – to obtain an identifier number. In addition to filing the T2062 forms, the non-resident must file information supporting the proposed transaction, such as an agreement for sale.  The T2062 form must be submitted to the CRA within 10 business days of the date that the agreement has been entered into. Because the uncertain nature of the time it will take to secure a Certificate of Compliance on the transaction, it is advised to allow for as much time as possible from the time of the sale agreement to the time of completion of the sale.  This will hopefully provide ample time for the CRA to receive the application package, receive and additional information that may have been missing in the original submission (if necessary) and process and approve the Certificate of Compliance. All required documentation must be sent to the Tax Services Office nearest to where the property is located. Once the CRA is satisfied with the reporting, documentation and payment, it will issue a Form T2068, Certificate – The Disposition of Property by a Non-Resident of Canada. Approval of the T2062 form, and processing of the Certificate of Compliance, authorizes the non-resident’s lawyer conveyancing the transaction to remit to the CRA 25% of the estimated capital gain as reported on the T2062 form.     If you have any questions or want to speak further about your tax situation, contact Nicholas Kilpatrick at nkilpatrick@burgesskilpatrick.com   Nicholas Kilpatrick is a partner with the accounting firm of Burgess Kilpatrick and specializes in tax structuring and business development for his small and medium business sized clients.  Please visit our website at www.burgesskilpatrick.com or on Facebook at www.facebook.com/Burgess Kilpatrick for more information on our firm.  This article has been paraphrased from an article by Steve Suarez of Borden Ladner Gervais, Toronto, titled “Canada’s 88(1)(d) Tax Cost Bump: A guide for Foreign Purchasers.          

    Leading Tax Advice Call Nicholas Kilpatrick 604-612-8620     Sections 115 and 116 of the Income Tax Act (ITA) deal with Canadian sourced income and capital gains generated on taxable Canadian property by individuals not residing in Canada.  Sections 212 to 219 deal with tax provisions that apply to non-resident corporations, but which also provide additional insight regarding Canada’s approach to international tax policy as it relates to individuals. Taxation in Canada is determined by residency, and while it can appear a simple task to determine whether one is a resident of Canada or not, fact patterns existent can complicate this determination to the point that sitting judges of Canada’s Tax Court have in many cases had to deliberate on the question of whether or not one is a resident before proceeding to adjudicate on other matters before them. Non resident tax return Canada policies are different and one needs to determine their residency before learning about them. If a non-resident, the taxpayer is taxed on Canadian sourced income (such as Canadian pensions, investment income, and dividends of corporations resident in Canada), and the sale of taxable Canadian property in accordance with the Tax Treaty or Information Exchange Agreement (IAE) between Canada and the jurisdiction that the taxpayer resides in.  Absent a tax treaty or IAE, non-resident tax on Canadian sourced income and the sale of taxable Canadian Property is generally taxed at a rate of 25% on proceeds received. Such an onerous tax rate can place non-resident individuals at a severe disadvantage compared to resident individuals.  Canadian residents enjoy access to tax credits, tax on only 50% of the gain on the sale of taxable Canadian property, and reduced administrative filing requirements.  While providing a positive contribution to the Canadian economy is the traditional logic behind access to tax credits for residents but not non-residents, in some cases such a high tax rate exposure imposed on the non-resident contravenes the existing fact pattern and can be inconsistent with the spirit of fairness and equity that the Income Tax Act purports to facilitate. For this and other reasons, the ITA provides various remedies to reduce the tax exposure on non-residents down to a rate more closely resembling that which a Canadian resident would experience.  Such an attempt for tax parity via those remedies is symptomatic of the underlying intent of the tax treaties and ITA’s that Canada enters into, which is simply to recognize at the transaction level the country of residency of the taxpayer and the tax liability to which s/he would be exposed had the income been generated in that resident country. Administrative guidelines in the ITA provide for a definitive process of applying Canadian non-resident tax rates on income generated on Canadian property by a non-resident taxpayer (“Canadian income”), and then providing for a foreign tax credit on the taxpayer’s resident personal income tax return equal (in theory, not necessarily in practice) to the Canadian tax paid on that income. Here you will learn about different solutions offered to the non residents for tax purposes Canada which will help lessen their tax liabilities. Furthermore, in this article describes various provisions within the ITA to reduce the tax exposure to non-residents on Canadian sourced income; provisions dealing with non-resident tax on the sale of taxable Canadian property and dividends from resident corporations will be dealt with in Part II of this article series on non-resident tax.   NR5 The NR5-Application by a non-resident of Canada for a Reduction in the Amount of Non-Resident Tax form allows for the reduction of tax on qualifying Canadian income earned by non-residents.  Such qualifying income includes Canada Pension Plan and Old Age Security benefits, superannuation benefits, RRSP and RRIF payments. Approval of this form is for a period of 5 years, and  renewal form will be sent to the non-resident before the due date, which as of the time of this writing was October 31 of the year prior to first year of the 5-year application period. The approval of this form necessitates the filing of a section 217 world income election tax return by the non-resident each year of the NR5 approval period.  Filing this form is of benefit to Canadian non-resident taxpayers receiving qualifying Canadian income in order to reduce unnecessary withholding tax on that income. We at Burgess Kilpatrick can assist you with the filing of this form and other non resident tax return Canada services as well.     Act Now To Get Our Value Pricing Adjustment on Audit and Review Engagements For Your Business     NR6 The NR6 – Undertaking to File an Income Tax Return by a Non-Resident Receiving Rent from Real or Immovable Property reduces the amount of tax installments that must be remitted by non-resident owners of Canadian rental property on income received from that property.  If an NR6 form is not approved, the non-resident owner would have to remit monthly tax installments to the CRA equal to 25% (absent a reduction allowed by a tax treaty or IEA) of the gross rental income received, with no regard to rental expenses incurred. Submission of the NR6 for is done each year for approval of the following application year, and involves providing an estimate of rental income and expenses for that year.  Tax equal to 25% of the net income amount (“yearly tax amount”) is calculated and remitted to the CRA for approval,  If approved the non-resident taxpayer will now be required to remit monthly installments equal to 1/12 of the calculated yearly tax amount.  As of the time of this writing, the due date of the NR6 form is October 31 of the year prior to the beginning of the application year, and includes the following requirements:  

• Creation of a Non-Resident Tax Number (NRF or NRH) number. This number is used by the CRA to administer monthly tax installments remitted by the non-resident taxpayer.  All tax installments remitted by the non-resident will be allocated to this tax number.
• Canadian payer agent. Non-resident taxpayers are required to appoint a Canadian agent who bears the legal obligation to withhold and remit tax on Canadian rental income generated by the non-resident to the CRA on the non-resident taxpayers behalf. Such a representative can be approved by submitting a from NR95 – Authorizing or Cancelling a Representative for a Non-Resident Tax Account.

  NR4 and NR4 Summary Where a non-resident taxpayer receives Canadian income and must remit tax on that income, the NR4 – Statement of Amounts Paid or Credited to Non-Residents of Canada form must be submitted to report the cumulative tax installments paid on the Non-Resident Tax Account for the year during which the installments were received.  This NR4 Summary form is a total of all individual amounts reported on the NR4 forms submitted for that tax number and is identical in purpose for the non-resident taxpayer as the form NR4 Summary is for a Canadian employer. That is, to reconcile the total tax installments allocated to a particular tax remittance number for the year to the calculated tax owing in that year.  As of the date of this writing, the due date for the NR4 and NR4 summary is March 31 of the year following the reporting year.   Section 216 tax return The section 216 tax return must be submitted by April 30 of the year following the reporting year and reports the rental income collected and expenses incurred by the non-resident taxpayer on that property for the reporting year.  The tax installments reported on the NR4 Summary form should also be reported as installments paid on the section 216 tax return.   Section 217 world income tax return Generally, Canadian payers of Canadian income to non-resident taxpayers must withhold and remit tax on that income.  Such tax represents the final tax obligation to the non-resident taxpayer on that income and does not necessitate the filing of an additional tax return. However, it may be advantageous for the non-resident to submit a tax return to report the Canadian income received.  In such a case, the non-resident is electing under section 217 of the ITA and may receive a refund of tax paid. This tax return is normally filed in situations where the non-resident tax payer has paid Canadian tax in excess of what s/he is required to pay. This tax return does not include the rental income reported on the section 216 tax return, although this amount, along with other, non-Canadian sourced income, must be reported in order to calculate Canadian tax credits to which the non-resident taxpayer is entitled (ie: the amount of some Canadian tax credits is based on the proportionate amount of Canadian income to total world income received for the reporting year). The preceding is just a summary of some of the reporting obligations non-resident Canadian taxpayers must adhere to. This is not an exhaustive summary of all obligations, and our office is available to answer your questions regarding your particular situation. A comparison of Canada’s international tax policy to that of other countries is an interesting exercise in determining not only Canada’s approach to attracting international investment, but also the components of international investment that Canada deems important to its’ continued economic prosperity and international competitive position; in many situations and policy decisions, the former drives the latter. Here at Burgess Kilpatrick, we guide non resident for tax purposes Canada and more other services.   If you have any questions or want to speak further about your corporation, contact Nicholas Kilpatrick at nkilpatrick@burgesskilpatrick.com   Nicholas Kilpatrick is a partner with the accounting firm of  Burgess Kilpatrick and specializes in tax structuring and business development for his small and medium business sized clients.  Please visit our website at www.burgesskilpatrick.com or on Facebook at www.facebook.com/Burgess Kilpatrick for more information on our firm.  This article has been paraphrased from an article by Steve Suarez of Borden Ladner Gervais, Toronto, titled “Canada’s 88(1)(d) Tax Cost Bump: A guide for Foreign Purchasers.

    Leading Tax Advice Call Nicholas Kilpatrick 604-612-8620     The concept of corporate and personal tax planning over the last 10 years has become more complicated as the Canada Revenue Agency (CRA) continues to take steps to prevent avoidance of tax by taxpayers.  Violation of the Income Tax Act can be triggered by taxpayers even in cases where there was no intent to avoid tax; unfortunately, however, such violations, albeit unintentional, may still result in expensive tax penalties imposed by the CRA For this reason, it is very important that corporate shareholders and/or personal taxpayers understand the legitimate corporate and personal tax planning opportunities available to them so that corporate and personal financial and tax affairs can be structured in a tax efficient manner. At Burgess Kilpatrick, with effective personal and corporate tax planning strategies, you can secure financial order. I have included here explanations of various corporate and personal planning opportunities that, depending on your situation, may result in tax savings compared to what one otherwise would have to pay if no tax planning preparations are undertaken. We start with the situation of the family-owned business, where there exist several opportunities within the Income Tax Act to plan for the following:

• Transfer of wealth to the next generation
• Minimize tax exposure

  THE CLASSIC ESTATE FREEZE One strategy that is critical to business succession and that is invariably found in any carefully considered tax plan is the estate freeze.  This concept allows for the succession of the future growth of the business from the owner-manager to the next generation.  The concept also allows the owner-manager to bring children into the corporate structure without adverse tax consequences. In a typical estate freeze, the children will subscribe for a new class of voting shares within the company (the growth shares), and the shares held by the owner-manager will be rolled over to a special “preferred” class of shares utilizing subsection 85(1) of the Income Tax Act. These preferred shares will retain their original cost, but can be redeemed for proceeds equal to their value at the time when they were rolled over.  Although available for redemption at any time, these shares are normally redeemed only when there is sufficient cash within the company to warrant the redemption.  Tax is payable only when the shares are redeemed and the owner receives the cash or similar personal benefit. Additionally, with the use of a discretionary trust, this strategy allows the owner-manager to effectively retain control of the corporation while providing for multiplication of the Capital Gains Exemption to the beneficiaries of the trust (ie: where the growth shares are retained by the trust). It is one of the most feasible tax planning strategies for companies. The following diagram illustrates this plan:   BEFORE             AFTER                                       In the before diagram, there was no provision for the owner-manager to be able to pass down ownership of the corporation to the children. In addition, if the owner wanted to take money out of the company, either as salary or as dividends, the amounts withdrawn would be subject to his/her marginal rates. In the after diagram, a freeze of the owner’s shares can be enacted, thereby passing on any future growth of the company to the children.  The discretionary trust provides the added benefits of Capital Gains Exemption multiplication and protection of assets, since creditors are unable to penetrate the trust to retrieve value from the assets held within it. For more such viable tax planning strategies for small businesses or new business, feel free to reach out to us.     Premium Accounting and Tax Assistance - call Nicholas Kilpatrick at 604-327-9234 to find out more for your business and click here to see our latest first-time offers.       REORGANIZING TO SPLIT INCOME When an individual incorporates a business, the primary intention is to work as hard as possible to earn enough money to pay the bills.  Hopefully, that effort will pay off and wealth will accumulate in the corporation.  The preferred corporate tax rates in Canada allow income retained in the corporation to be taxed at a substantially lower rate than if it was taken out as a salary or dividends by the owner. However, the issue now becomes how to take that wealth out of the company tax efficiently.  The Income Tax Act allows the business owner to reorganize the corporate structure so that the owner can pass income and/or dividends to the spouse and children which is then taxed at their individual personal rates (assuming the children are over the age of 18).  In the case of dividends, this is referred to as “dividend sprinkling”.  The main planning issues related  to such an income splitting arrangement are that:  

• The owner must retain access to the Capital Gains Exemption
• There is provision to allocate inter-corporate dividends within the corporate structure.

        In the preceding diagram, the owner has reorganized the corporate structure to include a holding company (Holdco), which allows dividends to be passed from Opco up to Holdco and then sprinkled out to the spouse and children at their respective personal tax rates.  If the spouse and children are to be paid salary, then the Income Tax Act stipulates that a reciprocal amount of work must be performed to earn that salary.   By maintaining the discretionary trust in the corporate structure (discretionary meaning that the owner/trustee has discretion as to how funds within the trust are allocated), there is provision to move non-business assets up to the trust and protect them from creditors.     MAXIMIZING THE CAPITAL GAINS EXEMPTION AND TAX PLANNING OBJECTIVES A comprehensive tax plan will normally involve the following:

• Maximization of the Capital Gains Exemption.
• Ability to split income.
• Facilitate the movement of inter-corporate dividends.
• Separation of business vs. non-business assets to maintain qualified small business corporation (QSBC) status and protect against legal and creditor actions.
• Transfer of wealth.
• Estate planning and tax minimization on death.

  Most business owners will concentrate on reorganizing tactics that will minimize their tax liability, either now or in the future.  A main consideration in business succession planning is whether or not the business will remain within the family (ie: will the children want to take over the business).  If not, tax planning takes on a different set of issues. If not remaining within the family, the owner will want to make sure that the business is eligible for the Capital Gains Exemption upon the sale.  This exemption is available to individuals only and is available on the sale of qualified farm property and upon the sale of shares of Canadian qualifying small business corporations (QSBC’s).  Planning must be undertaken in order to ensure that the business establishes and maintains this qualification. At Burgess Kilpatrick, we offer expert tax advice Canada for such companies as well also in order to qualify, the business must meet the following:  

• At the time of the sale, at least 90% of the assets held by the business must be used to earn business income
• During the 24 month period prior to the sale, at least 50% of the assets held by the business must have been used to earn business income.

  Achieving and maintaining this criteria over the critical 24 month period becomes important when the business contains excess cash from operations.  Cash reserves invested in fixed investments, for example, will not qualify under the business use criteria and may disqualify the business from the Exemption.  Real estate investments paid for with business profits and held in the corporations name will also disqualify the business from the Exemption if the fair market value of the real estate is in excess of 50%/10% of the fair market value of the assets held by the business. Meeting the criteria for the Capital Gains Exemption becomes a priority issue when the business begins to retain excess profits that are not re-invested into operations, either because such re-investment is unnecessary or because the owner-manager wants to retain a financial buffer to protect against future seasonal business fluctuations. The importance of maintaining eligibility for the Capital Gains Exemption is heightened by the fact that the corporate structure can be situated to multiply the Exemption to in order to further minimize the tax liability upon sale. For example, if the above diagram was altered slightly as follows:         The diagram is altered only to include the owner-manager as an additional shareholder in Opco.  With this arrangement, when the shares of the business are sold, and assuming that these shares meet the criteria of qualified small business corporation shares, the shares owned by the owner-manager and by the trust will all be eligible for the Capital gains Exemption.  Even though a trust is considered to be a separate entity, amounts flowing to each beneficiary up to the Exemption limit of $750,000 will be eligible for the Capital Gains Exemption. This arrangement facilitates the maximization of the Capital Gains Exemption upon the sale of the business, although it must be noted that, since the Exemption is a one-time provision, the beneficiaries will not be able to use this exemption again.  This is usually not a problem because great importance can be placed on the ability to take advantage of this tax saving when it is available (ie: there is always the possibility that this Exemption can be cancelled via legislation). Having the Holdco in place in the corporate structure enables the “purification” of Opco by facilitating the transfer to Holdco of assets unnecessary to the operation of Opco and thereby maintaining qualified small business corporation status.  The existence of Holdco also provides for the income splitting mechanism by allocating dividends through Holdco to its respective shareholders. Burgess Kilpatrick takes pride in offering such exemplary tax planning strategies for small businesses that would help shape your finances and keep your business afloat.   REORGANIZING THE BUSINESS STRUCTURE When an owner-manager has been operating and building a business for a significant number of years, a significant amount of wealth may have accrued in the business.  In order to protect the assets of the business and facilitate income splitting through salary issuance and dividend sprinkling, the above mentioned techniques can be incorporated to reduce tax liability and protect business assets. However, in cases where 2 or more individuals previously came together to establish the business, either to utilize complementary skills or combine start-up financing resources, and now want to take their respective shares in the accumulated wealth of the business and continue on with their own individual businesses, the Income Tax Act contains provisions to enable the division of the corporation’s assets among its shareholders in a series of tax-deferred transfers.  This technique of dividing the corporation’s assets among the respective shareholders is effectively called a “butterfly-type” reorganization, metaphorically termed to represent the “opening up” of the corporation’s assets and allocating them to its respective shareholders. The objective of a butterfly-type transactions is to separate the interests of shareholders and in effect “demerge” the corporation.  The usual procedure to do this is for each shareholder to create a holding company (Holdco) into which his/her interest in the operating company (Opco) would be transferred.  The Holdco’s would then continue to operate as independent operating companies. Unless the re-organization is effected the a tax-deferred manner, the application of subsection 69(5) of the Income Tax Act will deem the assets to be transferred to the holding companies at fair market value, which may result in punitive tax consequences if the assets have appreciated in value. Consider the diagram below:       In this situation, there are 2 shareholders, A and B, each owning 50% of Opco.  A and B would each create a holding company into which 50% o the assets of Opco would be transferred, and then Opco would be wound-up. The transfer of shares to the holding companies would create a deemed dividend under subsection 84(3) of the Income Tax Act; however, these dividends would be free of tax by virtue of the fact that they are flowing between connected corporations (meaning that the recipient of the dividend directly owned more than 10% of the voting shares of the payer corporation, the fair market value of which exceeded 10% of the fair market value of the total outstanding shares of the payer corporation at the time of the dividend issuance), and are therefore considered to be “inter-corporate” dividends.     Get Access to leading accounting and tax help. The time is now to get the right help and not waste any more effort getting mediocre results - call Nicholas Kilpatrick at 604-327-9234.   Ordinarily, subsection 55(2) of the Income Tax Act prevents this type of transfer as an inter-corporate dividend.  The Canada Revenue Agency enacts sections of the Income Tax Act to ensure that the transfers of certain types of property at values different than their cost base are taxed in accordance with the provisions contained within the Act.  In cases of the transfer of capital property this means that any increase in the transfer value normally is taxed at 50% of the increase between the cost and fair market value at the time of the transfer. Subsection 55(3), however, prevents the imposition of subsection 55(2) on inter-corporate transfers in 2 cases:

• where the reorganization is internal (subsection 55(3)[a]))
• where the reorganization is a true “proportional” butterfly (subsection 55(3)[b])), meaning that the shares received by the holding companies are on a pro rata basis (ie: in proportion to the ownership levels held in Opco at the point in time immediately preceding the transfer).

  Subsection 85(1) of the Income Tax Act allows this transfer to proceed on a tax-deferred basis (ie: there would be no tax imposed on the transfer of the assets even if the value at time of transfer was greater than the cost of those assets to Opco), provided that the transfer proceeds on a proportional basis (ie: in accordance to subsection 55(3)[b].   ESTATE PLANNING TECHNIQUES The issue of estate planning takes on a greater level of importance when significant wealth accrues within the family.  In cases where the owner-manager has built and established a business (or businesses) that have generated the family wealth, consideration must be given not only to the tax-effective distribution of financial resources to beneficiaries, but also to the liquidation of business assets and to the succession of the business either to the next generation or to an arms-length party. The following discussion does not cover all the issues inherent in a situation as the one described above, but rather considers a few techniques that can be employed to reduce the tax burden upon the death of an individual.  For a more extensive discussion on tax planning options to an estate, please contact our office.  

TAX TREATMENT AT DEATH

Consider the situation where a taxpayer of a private corporation dies.  When this happens, he or she is deemed to have disposed of the shares in that corporation at fair market value (FMV) immediately prior to death, unless the shares are rolled over to a spouse, common-law partner, or a spousal/common-law partner trust. The deemed disposition results (usually) in a capital gain, 50% of which is taxable and must be reported on the final tax return of the deceased.  The estate acquires the shares for an adjusted cost base (ACB) equal to the FMV immediately before death.  However, the paid-up capital (PUC) of the shares is unaffected, which will result in double taxation if the shares are later redeemed by the corporation to provide the estate with cash.  Consider the following illustration:         If the shares are later redeemed by the corporation, there will be a deemed dividend under subsection 84(3) of the Income Tax Act and also a capital loss.  The amount of the deemed dividend will be the difference between the paid-up capital on the shares and the fair market value at the time of redemption.   Only if the shares are redeemed within the first year after death can the capital loss can be carried back and reduced against the capital gain originally reported on the personal return (under s164)(6) of the Income Tax Act).  Otherwise, double taxation will result – first as a capital gain on the deceased person’s tax return, and a second time as a dividend, in the tax return of the estate or the beneficiaries. Like What You're Reading? Read More at:     Consider the following example:  At the time of his death Howard holds 1000 shares in ABC Inc. with an FMV of $2,000,000 and an ACB and PUC of $20,000.  There will be a deemed disposition of $1,800,000 and a taxable capital gain at 50% of $900,000 which must be reported on his final tax return.  Subsequently, and within the first year following death, the shares held by the estate are redeemed by ABC Inc.  The redemption will trigger a deemed dividend.  The tax liability is as follows:  

CAPITAL GAIN AT DEATH

  Proceeds (FMV)                $2,000,000 Less: ACB                                   (20,000) Capital Gain                          1,800,000   Taxable (50%)                         900,000   Tax (35%)                               $315,000  

REDEMPTION OF SHARES BY ESTATE (1st year)

  Proceeds (FMV)                $2,000,000 Less: PUC                                   (20,000) Deemed dividend [84(3)]     1,800,000   Tax (35%)                                 $630,000   Dividend tax credit (approx 13.5%)                      (85,050)   Tax paid                                  $544,950  

CAPITAL LOSS CARRIED BACK TO PERSONAL RETURN

  PUC                                       $20,000 Less: Proceeds under Deemed dividend       (2,000,000) (1,800,000)   Offset against capital gain on personal return s164(6)                             1,800,000              Net capital gain                                             0   Tax refund received        ($315,000)   The net tax paid under this scenario is $544,950, which is the amount of the deemed dividend under part B of the example.  However, if the redemption is deferred until after the 1st anniversary of the date of death, then double taxation will result and the total tax paid on the set of transactions with be $859,950 – a tax rate of 43%.    II-            UTILIZATION OF CONNECTED CORPORATION AND s.112(1) INTER-CORPORATE DIVIDEND  Although the election under s164(6) will reduce the tax paid to the deemed dividend amount, a second technique to further reduce the tax owing upon death is for the estate to transfer the shares to a holding corporation that is connected to ABC Inc. (connected meaning that the recipient of the dividend directly owned more than 10% of the voting shares of the payer corporation, the fair market value of which exceeded 10% of the fair market value of the total outstanding shares of the payer corporation at the time of the dividend issuance).  The following diagram illustrates this technique:     In exchange for the transfer, the holding company will give the estate a note payable equal to the cost (ACB) of the shares to the estate.  Once the shares are in the holding corporation, they are then redeemed by ABC Inc.  Because the holding company and ABC Inc. are connected, the deemed dividend  is considered inter-corporate and therefore non-taxable, except for any Part IV tax if the payer receives a dividend refund,  The holding company then pays the $20,000 note to the estate. In the above scenario, the only tax paid on the shares is the capital gain of $315,000, which is a reduction of $229,950, or just over 11 tax percentage points when compared to the net tax paid in the first scenario.         CONCLUSION The above issues represent only a small aspect of potential tax planning techniques that can be implemented to legitimately minimize tax and implement a strategy to effect income splitting and asset protection.  In most tax planning scenarios, consideration must be given to qualitative as well as  quantitative, or monetary concerns, such as parity to beneficiaries, quality of life to the owner-manager and the spouse, philanthropic desires and vehicles available to realize those desires on a tax-efficient basis, etc. Regardless of the situation, long-term planning and implementation of a well-considered strategy will result in legitimate tax minimization and the optimal allocation of resources among those involved in the tax planning process. We at Burgess Kilpatrick have been offering valuable assistance for corporate tax planning for companies Canada and aim to continue doing so. If you have any questions or want to speak further about your corporation or estate planning matters, contact Nicholas Kilpatrick at nkilpatrick@burgesskilpatrick.com   Nicholas Kilpatrick is a partner with the accounting firm of Burgess Kilpatrick and specializes in tax structuring and business development for his small and medium business sized clients.  Please visit our website at www.burgesskilpatrick.com or on Facebook at www.facebook.com/Burgess Kilpatrick for more information on our firm.