On December 22, 2017, the U.S. Tax Cuts and Jobs Act was signed into law. This has brought about many changes to U.S. tax law. These changes are fundamental and have many implications for cross-border tax planning. We are actively following all developments related to the U.S. tax reform, and how this affects our clients.
There have been many significant changes to both corporate and personal income taxation in the U.S. Some key changes are as follows:
Foreign persons were able to conduct business or investment activities in the U.S. without identifying themselves to the IRS if they were using a “domestic disregarded entity”. This includes LLCs owned by a single foreign owner. The IRS now requires domestic disregarded entities to disclose the owner starting in the 2017 tax year.
Disregarded entities that are directly or indirectly owned entirely by a single-foreign person are required to file an information return (Form 5472).
U.S. corporations that are at least 25% owned by foreign persons must also file Form 5472. They must keep permanent books of account or records and they must be sufficient to substantiate the accuracy of their U.S. federal income tax returns.
Failure to meet the reporting and record maintenance requirements will result in a penalty of $10,000 for each failure to comply with these rules. The penalties may increase by an additional $10,000 every 30 days in the case of a failure to comply within 90 days after the IRS has issued a notice of failure.
CUTT closely monitors developments pertaining to the Base Erosion and Profit-Sharing (BEPS) initiative.
BEPS is an OECD project aimed at setting new international standards for many issues including:
The BEPS final report was published on October 5, 2015 and includes agreed upon minimum standards to be adapted internationally. In 2016, negotiations were concluded for a multilateral convention (MLI). The MLI outlines steps for signatories to implement the BEPS proposals, including updates to international tax rules and recommendations for tax treaties and policy so they are uniformly implemented.
For the MLI to be binding in Canada, it must be ratified by the Canadian Parliament. As of January 1, 2018, no official timeline for the ratification has been disclosed. The MLI will only apply to tax treaties between two countries if the MLI has been ratified and is in force in both tax jurisdictions.
Canada has adopted the OECD Common Reporting Standard (CRS) effective July 1, 2017. Under the CRS Canada will automatically exchange information on financial accounts with foreign tax authorities.
The IRS issued regulations requiring companies with annual revenue of $850 million or more to report on a country-by-country basis information on their profit, loss, and accumulated income.
The automatic exchange of information is a new international standard of tax cooperation as set out in the Common Reporting Standard (CRS). More than 100 jurisdictions, including Canada, are committed to implement the CRS.
Under the CRS, financial institutions must take steps to identify certain accounts held by, or for the benefit of, non-residents and to report such accounts to the Canada Revenue Agency (CRA). The information would then be available for sharing with the jurisdiction in which the account holder resides for tax purposes under the provisions and safeguards of the Multilateral Convention on Mutual Administrative Assistance in Tax Matters or the relevant bilateral tax treaty.
On December 15, 2016, Part XIX was added to the Canadian Income Tax Act, implementing the CRS due diligence and reporting obligations in Canada. This legislation together with the administration by the CRA will allow the CRA to exchange financial account information with participating jurisdictions beginning in 2018.
Canada and the U.S. signed an intergovernmental information exchange agreement in relation to FATCA in 2014, and financial information is exchanged between the two countries.
In line with new developments in BEPS and the OECD regarding transfer pricing, both the IRS and CRA are increasing their scrutiny of cross-border transactions between related parties.
As a result, small and medium sized businesses are experiencing an increase in transfer-pricing audits.
Our methodology is to group transfer pricing transactions into the following general areas:
Our experience is that the IRS and CRA have focused primarily on the first three areas when performing transfer-pricing audits.
The CRA is applying the OECD guidance and requires companies to establish transfer pricing agreements that conform to OECD transfer pricing guidelines. These agreements must provide economic support of arm’s length terms, as well as complete and accurate descriptions of the transactions. The CRA however, has not adjusted their requirements to include OECD transfer pricing guidance to include the treatment of “cash boxes” affecting outbound financing of foreign subsidiaries of Canadian multinationals and BEPS’ proposed simplified approach to low value-adding services.
OECD Action 13 has been implemented and requires corporate groups with annual consolidated revenues exceeding €750 million to maintain:
US reporting requirements are set forth in the Treasury Regulations, and are also similar to the OECD transfer pricing guidelines.
Report of Foreign Bank and Financial Accounts (FBAR)
U.S. persons meeting the criteria listed below must file an FBAR annually with the U.S. Department of Treasury using FinCen Report 114. The FBAR has the same filing deadline as individual income tax returns (although they are not filed together). Accordingly the FBAR filing deadline for an individual is April 15, with an automatic six-month extension to October 15.
U.S. persons are required to file an FBAR if:
The following are considered U.S. persons:
The FBAR must be filed electronically. Failure to properly file the form may be subject to penalties. The penalty is inflation adjusted. For penalties assessed after August 1, 2016, non-willful violations may result in a civil monetary penalty of $12,459.
Willful failure to file may be subject to a penalty equal to the greater of either $124,588 or 50% of the balance in the account at the time of the violation, for each violation.
Form 8938 was introduced in 2010, and is which is included in the 1040 tax return and should be filed in addition to the FBAR.
An individual who holds any interest in a specified foreign financial asset (SFFA) during the taxable year is required to file Form 8938. A specified foreign financial asset includes:
Gold held in a safety deposit box, artwork, interests in a social security, social insurance or other similar program, and personally owned real estate do not constitute specified foreign financial assets.
However, gold held by a custodian, interests in foreign trusts, foreign estates, foreign pension plans, and foreign deferred compensation plans do constitute a specified foreign financial asset.
Real estate held in a trust or other entity is not reportable by the individual. However, an interest in a foreign trust or foreign entity is reportable on separate tax returns which are then identified as filed on the FATCA form. Additional stock issued by a foreign corporation is a specified foreign financial asset.
Starting in 2015, Canada and the U.S. started to share financial and tax information, with Canada providing information to the U.S. and vice versa.
The agreement requires Canadian financial institutions to report financial information on accounts held by U.S. residents and U.S. citizens (including U.S. citizens who are residents or citizens of Canada) to the Canada Revenue Agency (CRA), who then transfer this information with the IRS.
In addition, the IRS provides the CRA with increased information on certain accounts of Canadian residents held at US financial institutions.
Several exemptions are listed in the agreement. For example, the following are exempt from FATCA and will not be reportable:
Smaller deposit-taking institutions, such as credit unions with assets of less than $175 million will be exempt from this obligation.
The 30% FATCA withholding tax will not apply to clients of Canadian financial institutions. It will only apply to a Canadian financial institution if the financial institution is not compliant with its obligations as set out by the agreement.
Americans who are Canadian residents and non-compliant with their U.S. tax filing requirements should be aware that Canadian financial institutions report information regarding their investments to the IRS. The same applies for Canadians with U.S. tax filing requirements.
Taxpayers who own more than $100,000 of specified foreign property at any point during the year must file form T1135.
The CRA has simplified procedures for taxpayers who hold specified foreign property with a total cost base of more than $100,000 and less than $250,000 at any time in the tax year.
Taxpayers who hold more than $250,000 of specified foreign property must continue using the current detailed reporting method.
Specified-Foreign Property includes funds held outside Canada, shares of non-resident corporations (including those held in Canadian brokerage accounts), debts owed by non-residents (such as bonds issued by non-resident corporations and governments), interests in non-resident trusts, real property outside of Canada, and other property outside Canada.
Form T1135 is due by the filing deadline for the taxpayer’s income tax return for the year. The basic penalty for a missing or incomplete form is $25 per day or $100, whichever is greater, up to a maximum of $2,500. There are harsher penalties for taxpayers who knowingly fail to file the T1135 or make false statements.
The IRS introduced the Streamlined Filing Compliance Procedures in 2012 to provide U.S. taxpayers (individual taxpayers and estates of individual taxpayers) who had failed to report and pay taxes on foreign financial assets with:
The failure to report and pay taxes must not have resulted from willful conduct on their part. Non-willful conduct is conduct that is due to negligence, in advertence, mistake, or conduct that is the result of a good faith misunderstanding of the requirements of the law.
Returns submitted under these procedures may be selected for audit under existing audit selection processes applicable to any U.S. tax return. They may also be subject to verification procedures. This means that the accuracy and completeness of submissions may be checked against information received from banks, financial advisors, and other sources.
If a taxpayer is concerned that their conduct was willful, they should consider participating in the Offshore Voluntary Disclosure Program.
After a taxpayer has completed the streamlined filing compliance procedures, he or she will be expected to comply with U.S. law for all future years and file returns according to regular filing procedures.
In order to be eligible for the program:
Streamlined foreign offshore procedures (not residing in U.S.)
In order to be eligible for Streamlined Foreign Offshore Procedures, U.S. taxpayers (individuals or estates of individuals) must:
The procedures for eligible U.S. taxpayers are to:
The full amount of the tax and interest due in connection with these filings must be remitted with the tax returns.
Streamlined domestic offshore procedures (residing in US)
The procedures for eligible (cannot meet the non-residency requirement) U.S. taxpayers (individuals or estates of individuals) are to:
The full amount of the tax, interest, and miscellaneous offshore penalty due in connection with these filings must be remitted with the amended tax returns.
Canadian “hybrid entities” are not entitled to treaty benefits and are subject to a 25% withholding tax on cross-border payments. Hybrid entities include Canadian Unlimited Liability Companies (ULC). Currently, ULCs exist in British Columbia, Nova Scotia, and Alberta.
Note that there are techniques that may be available to avoid the denial of U.S. Treaty benefits for certain situations.
U.S. formed LLCs have access to protection under the Canada-U.S. Tax Treaty when used to invest in Canada, and are entitled to treaty rates as follows:
Canadians considering investing in U.S. LLCs should be wary. In many situations this structure has negative tax implications for Canadian investors. The CRA does not allow access to important tax treaty benefits, which often results in double taxation.
On June 15, 2013, the Federal Court of Appeal rendered the first decision regarding Tower Structures in the FLSMIDTH Ltd. V. The Queen, 2013 FCA 160.
Tower structures are corporate configurations located in both the U.S. and Canada that utilize hybrid entities to structure their financing. By doing so, an interest expense will be deducted in both the American and Canadian entities. Many observers refer to these structures as a “double dip” as they take advantage of the different tax treatments which the IRS and CRA will apply to the same transaction.
The Federal Court of Appeal dismissed the taxpayer’s appeal of the Tax Court of Canada, ruling that the U.S. tax which was deducted by the Canadian corporation pursuant to subsection 20(12) was not deductible. Following this ruling, any Canadian corporation using a Tower Structure and claiming a section 20(12) deduction for U.S. (or other foreign) tax should review their structure and plan accordingly.
Foreign affiliate dumping is a situation in which a foreign parent company has a Canadian affiliate (referred to as a Corporate Resident in Canada) that invests in other foreign affiliates/subsidiaries of the parent company. Investing in the shares or debt of the other foreign subsidiary can have Canadian tax implications including a potential adjustment to the foreign parent’s paid up capital in the Canadian company or Canadian withholding tax.
When a Canadian parent company or a non-arm’s length person to a company (other than a foreign affiliate) borrows funds from the Canadian company’s foreign subsidiary, there may be a potential income inclusion to the Canadian entity if such loan remains outstanding for more than two years. Depending on the circumstances, an offsetting deduction may be available.
Canadian and U.S. tax laws limit the deductibility of interest on cross border loans in certain situations. Canadian thin capitalization rules now limit deductible interest on loans from certain non-residents at a 1.5:1 debt to equity ratio.
When arranging an intercompany loan, the purpose, nature, and terms of the loans should be considered. In some circumstances there could be deemed interest, income inclusions, or withholding tax implications.
Many U.S. corporations providing services in Canada continue to struggle to com-ply with Regulations 102 and 105. The 2015 Federal Budget introduced exceptions for payments made starting in 2016.
Regulation 102 requires U.S. entities that send their employees to work in Canada to open Canadian payroll accounts. The salaries earned in Canada is subject to Canadian payroll. U.S. employees working in Canada will be exempt from these requirements if they earn less than $10,000 annually in Canada. If the employee earns more than $10,000 annually, the employer can request to be exempt from Canadian payroll by filing a regulation 102 waiver.
Starting in 2016 the CRA removed the requirement for a qualifying non-resident employer to withhold and remit tax for a qualifying non-resident employee under the following circumstances:
Qualifying non-resident employee:
Qualifying non-resident employer:
Regulation 105 of the Canadian Income Tax Act imposes a 15% withholding tax on fees, commissions, or other amounts earned from services rendered in Canada by U.S. individuals and corporations. If these services are rendered in the province of Quebec, they will be subject to an additional Quebec withholding tax of 9%.
U.S. service providers can request a reduction or waiver from withholding either 30 days before the services are to commence in Canada, or 30 days before the first payment is due for these services.
Often these withholding taxes can be recouped. The U.S. entity must file a Canadian (and Quebec) tax return at the end of the entity’s fiscal year and claim a refund to the extent permitted on those tax returns.
Entities making payments to non-residents are required to appoint a withholding agent. A withholding agent is any person who has the control, receipt, custody, disposal, or payment of specified items of income to the extent it is gross income from U.S. sources.
Generally, withholding taxes are reported on Forms 1042 and 1042-S, and are filed with the IRS either on or before March 15th. The withholding agent is required to deposit the amounts withheld in a U.S. bank.
Reductions and Exemptions
The Canada-U.S. Tax Treaty reduces most withholding rates. A reduction or exemption from U.S. withholding under a treaty is generally made to the withholding agent. 1 File Form W-8BEN with the U.S. financial institution or withholding agent to claim treaty exemption or reduced rate of withholding. U.S. taxable income by a partnership and LLC with effectively connected income requires withholdings. Forms 8805 and 8813 are used to report the withholding tax.
Interest income may be exempt from withholding tax.
Americans who own Canadian real estate must:
Americans selling Canadian real estate must:
The PATH Act of December 2015 introduced changes regarding foreign investment in U.S. real estate. The main change is an exemption for qualified pension funds from FIRPTA. The PATH Act has also made changes to regulations on foreign investment in U.S. REITs.
Canadian real estate investors must:
If the buyer acquires the U.S. real property for use as a residence and the sale price does not exceed $300,000, there is an exemption from the withholding tax. If the amount realized exceeds $300,000 but does not exceed $1,000,000 and the property will be used by the transferee as a residence, then the withholding rate is 10% on the full amount realized. If the amount realized exceeds $1,000,000, then the withholding rate is 15% on the entire amount, regardless of the use by the transferee.
The 15% withholding is applicable to the ownership of U.S. real property held directly by individuals, indirectly through partnerships, and the ownership of stock in a U.S. real property holding corporation.
Real estate holders should be aware of the tax implications of the following activities:
The U.S. Estate Tax applies to all U.S. citizens (residing in the U.S. or abroad) and Canadians who reside in the U.S. (either via a green card or with established permanent residence.) It can also apply to Canadians who own real estate or tangible personal property in the U.S., or shares of U.S. companies.The new tax plan has increased many of the exemptions from previous years.
The following are the 2018 exemptions, which are subject to annual adjustment for inflation:
U.S. residents who maintain trusts under Canadian jurisdiction may be required to file special information returns regarding the assets held in the trusts. These trusts may be subject to income taxation. Not filing required information returns can subject the trust to substantial penalties (See “Other U.S. reporting issues”).
Non-residents who hold Taxable Canadian Property
In 2010, the Canadian Government instituted changes to the laws on tax collec-tion from non-residents on the disposition of Taxable Canadian Property. Canada only taxes individuals based on residency and does not consider the domicile of taxpayers for tax calculation purposes.
The 2010 Budget also amended the definition of taxable property to further align with international norms. This amended definition will limit the taxation of capital gains realized by non-residents to specified assets.
Specified assets are direct and indirect interests in Canadian real estate, Canadian resource properties, and timber resource properties. It should be noted that while the rules will be very similar to those in the United States, there is a signifi-cant difference regarding the ownership of the asset.
In Canada, if more than 50% of a specified asset is held by a corporation at any time during the prior 60 months, it will be considered taxable Canadian proper-ty, even if the corporation is non-resident. These rules do not apply to a deemed disposition upon death; however, the executor acting on behalf of a non-resident decedent must file an income tax return for the year of death and pay any tax that may be necessary on the deemed disposition.
Deemed Canadian Resident Trusts
A trust created outside Canada may be deemed to be a Canadian resident trust where:
E-Commerce transactions can raise many questions concerning sourcing the sale of goods and services, and the buyers location. A further complication to consider is the possibility of unintentionally creating a Permanent Establishment (PE) in a foreign country by maintaining a server there. This may require the allocation of revenue to the PE based on the activities conducted by or for the PE.
Expatriates are U.S citizens who relinquish their U.S. citizenship or long-term permanent residents who surrender their green cards. An increasing number of Americans have been expatriating despite the complicated renunciation process. In 2017, a record number of Americans formally renounced their U.S citizenship or residency.
Taxpayers must file an Exit Return the year of their renunciation, which triggers a deemed sale of their assets the day before the expatriation date at fair market value. This sale has a capital gains tax with an annually adjusted for inflation exclusion of $699,000 in 2017.
The tax attributable to the deemed sale of property may be extended until the due date of the return for the taxable year in which such property is disposed of, provided that an election to defer the tax is made. An irrevocable election to de-fer the tax may be made, however adequate security must be provided. Generally, a bond or letter of credit are considered acceptable security interests. Interest will be charged on any deferral of tax.
Certain property deemed sold will not qualify for the election such as:
Special rules apply to U.S. withholding on deferred compensation payments.
Only covered expatriates are subject to these deemed sale rules. A covered expatriate is a person whose:
Such a person must certify under the penalty of perjury that he or she has met the requirements for the 5 preceding taxable years. The $162,000 (2017) annual income is indexed for inflation ($139,000 in base year 2008).
A citizen shall be treated as relinquishing his or her U.S. citizenship on the earliest of:
Two exceptions to the exit-tax regime are:
Individuals considering expatriation should be aware that Congress enacted immigration legislation (the Reed Amendment) in 1996. This amended the grounds of visa ineligibility and of inadmissibility to the U.S. Under the Reed Amendment, any former U.S. citizen who officially renounced their U.S. citizenship and who is determined by the Attorney General to have renounced it for the purpose of avoiding taxation by the U.S. will be inadmissible to the United States and ineligible for a visa.
Long term residents of the U.S. terminate their resident status by:
A long-term resident is defined as an individual who has held a green card for any portion of at least 8 of 15 years preceding expatriation. Even one day in a year is considered any portion of a year.
Effective January 1, 2010 the fifth protocol to the U.S. Canada Tax Treaty introduced a new definition of Permanent Establishment (Article v). Cross border contractors are now be deemed to have a permanent establishment in the other country if they pass either:
Services are performed by an individual who is present in the other Contracting State for more than 183 days in a 12-month period and during this period more than 50% of the gross active revenues of the enterprise are generated from these services; or
Services are provided in the other Contracting State for more than 183 days in a 12-month period with respect to the same or connected project. These services are provided for customers who are either residents of, or maintain a PE in the other State and the services are provided to the other PE.
U.S. entities are required to register for and charge sales taxes if they meet the CRA definition of “carrying on business” in Canada.
Further to the 2011 introduction of the Harmonized Sales Tax (HST), the CRA implemented a number of significant changes to the regulations on supplies of services performed in Canada. The supply of services is generally based on the business address of the customer. There are exceptions for certain services, which include:
There is no change to the place of supplies of real property and goods by way of sale.
A supply of real property is considered to be made in the province where the property is situated and therefore the sale is subject to the provincial GST/HST rate. A supply of goods by way of sale is deemed to be made in a province if the supplier delivers the goods or makes them available to the buyer in that province.
Increased PFIC information has to be reported by U.S. shareholders annually on form 8621.
A new de minimis threshold amount was established relating to PFIC reporting. PFIC reporting is required if on the last day of the tax year either:
The IRS has provided regulations on determining indirect ownership and reporting requirements of PFICs. There are new anti-duplication rules so that stock is not counted twice when determining whether a person with an interest in a domestic corporation is an indirect owner of a PFIC that is held by that same domestic corporation.
There is also additional guidance on how PFIC shareholders should complete IRS Form 8621 and IRS Form 5471.
The IRS has issued final regulations in the past year on the recharacterization of certain intercompany debt instruments as equity for tax purposes in the U.S. These rules do not apply to the first $50 million of debt issued by a corporation (as short-term debt or funding new investments of a controlled subsidiary.)
Under Section 385, debt issued by a corporation to an affiliate is recharacterized as equity if it is issued:
In 2016, the IRS issued tough new regulations affecting inversion transactions. The tax consequences of transferring a domestic entity to a foreign entity in an inversion transaction are based on the percentage of ownership of the foreign corporation by the owners of the domestic entity before the transaction.
If the percentage is at least 60% but less than 80%, special taxes are applied to the inverted entity. If the percentage of ownership is at least 80%, the foreign corporation is treated as a domestic corporation for tax purposes.
The IRS has issued new regulations to limit the use of leveraged partnerships as a structure to take cash out of a business tax-free. Prior to these new regulations, partners could distribute cash tax-free if it was funded with partnership debt. Under these new regulations, the partnership’s liabilities will be treated as non-recourse liabilities in certain situations
In 2014, Canada introduced regulations to prevent the use of intermediaries to reduce withholding taxes on interest payments to non-residents or in the avoidance of thin capitalization rules.
Canada has now expanded the back-to-back rules, preventing the use of intermediaries to reduce withholding taxes by:
Canada has also extended the rules to include outbound loans (in an attempt to avoid shareholder loan rules).
Dividends paid between Canadian corporations are generally paid tax-free. However, there is an anti-avoidance rule in Subsection 55(2) of the Income Tax Act which prevents tax-free dividends from being paid when the purpose is the reduction or avoidance of capital gains on the sale of shares of the corporation that paid the dividends.
Subsection 55(2) now applies to tax-free intercorporate dividends when they were issued: