FAPI And Offshore Captive Insurance Arrangements
Paragraph 95(2)(a.2) of the Income Tax Act (Canada) was introduced as a measure to restrict the tax benefit associated with transferring income from the insurance of a risk in respect of a person resident in Canada, property situated in Canada or a business carried on in Canada (each a Canadian Risk) to an offshore captive insurance entity. In short, paragraph 95(2)(a.2) includes in income from a business other than an active business (which is included in foreign accrual property income, or FAPI) a foreign affiliate’s income from the insurance of Canadian Risks (and any income that pertains or is incidental to that income). Paragraph 95(2)(a.2), however, contains a de minimis exception that allows a controlled foreign affiliate (CFA) to earn up to 10% of its income from Canadian Risks without that income being subject to FAPI.
Budget 2014 Amendments
Paragraphs 95(2)(a.21) and (a.22) were introduced as part of the 2014 Federal Budget to curtail the use of certain arrangements (known as “insurance swaps”) designed to circumvent paragraph 95(2)(a.2). An insurance swap is essentially an arrangement whereby a CFA insures foreign risks, but maintains economic exposure to Canadian Risks (i.e., its return on the foreign risks “tracks” the return on the Canadian Risks). Prior to the 2014 Federal Budget, paragraph 95(2)(a.2) did not apply to insurance swaps because the CFA would not own the Canadian Risks; therefore, the income generated by the CFA from the insurance of the foreign risks, while economically tied to the Canadian Risks, would be included in its income from an active business, which is not included in FAPI.
Proposed Relieving Measure For Regulation 102 Withholdings By Non-Resident Employers
Remuneration paid for employment services performed in Canada (even for short-term assignments) by non-resident employees is subject to Canadian income tax withholding, remittance and reporting requirements under subsection 153(1) and regulation 102 (Reg. 102) of the Income Tax Act (Canada) (Act). On April 21, 2015, Finance Minister Joe Oliver tabled the 2015 Federal Budget in the House of Commons, which included a relieving measure for Reg. 102 withholdings (the Proposed Amendments). Although the Proposed Amendments have been welcomed by the tax and business communities as reducing the administrative burden of businesses engaged in cross-border trade, there are concerns that the measures do not go far enough.
The Current Reg. 102 Regime
Under Reg. 102, the remuneration received by non-residents for employment performed in Canada is taxable by Canada, subject to relief under an applicable tax treaty between Canada and the employee’s jurisdiction of residence. For example, an individual resident in the United States who is employed by a non-resident employer generally will be exempt from Canadian tax on remuneration from employment exercised in Canada if the employee is present in Canada for no more than 183 days in any 12-month period commencing or ending in the relevant calendar year and the remuneration is not borne by a permanent establishment in Canada.
Treaty Shopping Update
Treaty shopping has received a great deal of attention in Canada in recent years. Significant interest was initially generated by the federal government’s announcement in 2013 that it intended to adopt specific measures designed to curb the practice. Around the same time, the Organisation for Economic Co-operation and Development (OECD) released its Action Plan on Base Erosion and Profit Shifting (BEPS), which indicated that working groups would be tasked with formulating recommendations regarding certain issues or “actions,” including the prevention of treaty abuse (Action 6). Both the government’s and the OECD’s initiatives have undergone important developments over the past two and a half years. This article provides an overview of those developments and the current status of each initiative.
Canadian Government Initiative
As part of the 2013 Federal Budget, the Department of Finance (Finance) announced that it would be consulting with the Canadian tax community regarding possible measures that would “protect the integrity of Canada’s tax treaties while preserving a business tax environment that is conducive to foreign investment.” Later that year, it produced a consultation paper outlining several options in this regard, including both domestic and treaty-based measures designed to curb abusive treaty shopping (2013 Consultation Paper). The 2013 Consultation Paper contained several arguments supporting the view that it would be legal under international law for Canada to adopt a domestic anti-treaty-shopping measure. Several of these arguments were drawn from the OECD’s commentary on its model tax treaty (the OECD Commentary). The tax community was invited to comment on both the domestic and the treaty-based approaches discussed in the 2013 Consultation Paper; it was understood that the government would ultimately adopt one of the two options.