Tax Advisers - Deloitte

Canada
2006 – a year of significant
developments
Leslie Morgan
Blake, Cassels & Graydon
Toronto
The past year has seen important proposed legislation as well
as a number of judicial decisions. The most important
legislative proposals have been directed at the proliferation
of income trusts and flow-through partnerships as business
entities in Canada. The initial legislative proposal was to
reduce personal taxes on eligible dividends paid after 2005,
so as to provide taxable holders of public company shares
with the same after-tax return as holders of income trust
units. This would essentially eliminate double taxation on
corporate profits distributed to such shareholders.
Despite this proposal, many large public companies
announced plans to convert to income trusts and on October
31 2006 much bigger changes were announced. These new
proposals create a regime for publicly traded trusts and their
investors which is similar, but not identical, to that for public corporations and their
shareholders. The new rules apply to publicly traded Canadian trusts (other than
certain narrowly defined real estate investment trusts and those that hold only
portfolio investments). Under the proposals, the trust will be subject to a special tax on
distributions of income attributable to non-portfolio investments, at a rate that will
approximate the corporate tax rate. Investors will also be taxable on the distributions
as if they were dividends from a taxable Canadian corporation. The new rules will
apply to existing trusts publicly traded before November 2006 for taxation years that
end after 2010 and to entities that became publicly traded after October 2006 for the
later of their 2007 taxation year and the taxation year in which they began to be traded.
Similar rules are proposed for publicly-traded partnerships. The proposals state that
the hiatus in application may be revisited if there is “undue expansion”, as clarified in
a subsequent release, of an existing entity. In addition, the proposals contained an
unusually specific anti-avoidance statement to the effect that new structures designed
to frustrate the policy of the proposals may result in immediately effective changes.
Revised draft legislation dealing with Canada’s foreign affiliate rules, the foreign
investment entity rules (FIE rules) and the non-resident trust rules was released once
again in November of 2006. In light of the long implementation delay, the date of
application of the FIE rules and the non-resident trust rules has been moved back from
taxation years beginning after 2002 to taxation years beginning after 2006. The
proposed rollover for a Canadian resident shareholder who exchanges shares of a
Canadian corporation for shares of a foreign corporation first raised in 2000 has been
postponed again. Until the new rule is introduced, complex exchangeable share
structures will continue to be utilized in these circumstances.
The 2006 Federal Budget noted an intention to release a discussion draft of legislative
proposals that would permit certain corporations to report income in a currency other
than Canadian dollars where their business activities are conducted primarily in that
currency. Neither the expected date for release of these proposals nor their effective
date has been set.
In 2004, the Canada Revenue Agency stated that its policy was to challenge treatyshopping
arrangements. In 2005, the Canadian general anti-avoidance rule (the
GAAR) was amended retroactive to 1988 to clarify that the GAAR could apply to deny
treaty benefits. The decision in MIL (Investments) is the first Canadian tax case to
consider the legislative amendment to the GAAR in the context of a continuance to
Luxembourg shortly before a disposition of shares. At the Tax Court of Canada, the
taxpayer succeeded on the basis that in the circumstances the taxpayer’s reliance on the
provisions of the Luxembourg Treaty was not abusive tax avoidance. The Crown has
appealed the decision to the Federal Court of Appeal.
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