Principal Issues: (1) If a foreign affiliate is incorporated and resident in Country A, and only carries on an active business in Country B through a branch, assuming neither country has a tax treaty with Canada is it necessary that both Country A and Country B has a TIEA with Canada for the income to fall within the definition of "exempt earnings" in subsection 5907(1) of the Regulations? (2) If a foreign affiliate of a taxpayer is resident in a country which has a TIEA with Canada under the common law tests and that corporation carries on an active business in that TIEA country, but is incorporated in a non-TIEA and non-treaty country, will the income it earns be exempt earnings?
Position: (1) Yes. (2) Yes.
Reasons: (1) In order for income from an active business carried on by a foreign affiliate to qualify as "exempt earnings" the affiliate must be resident in a designated treaty country and its active business must be carried on it a designated treaty country. (2) For the purposes of LIX of the Regulations in determining where a foreign affiliate is resident, we look at where the foreign affiliate is resident under common law tests.
CLHIA Round Table Question #4
Tax Information Exchange Agreements ("TIEAs") and Exempt Surplus
Regarding the initiative to enter into TIEAs with other jurisdictions and the fact that income earned in a jurisdiction that has entered into a TIEA with Canada will be classified as exempt surplus for Canadian tax purposes, will the CRA clarify its position in the following situation:
Facts
1. A foreign affiliate ("FA") is incorporated and resident in Country A under the standard common law definition (i.e. where management and control of the company resides). The FA may, but does not necessarily carry on business in Country A. The FA has established a branch in Country B and carries on an active business through the branch.
2. A FA is incorporated in Country A but not resident in Country A under the common law definition. The FA however, is resident in Country B, under the standard common law definition, and carries on its entire business in Country B. All of the FA's income would qualify as "income from an active business" as defined in subsection 95(1) of the Income Tax Act (the "Act").
In both 1. and 2. above the FA is carrying on business in Country B through a "permanent establishment" as defined in subsection 5906(2) of the Income Tax Regulations (the "Regulations").
Question
In order for active business income earned in the branch to be classified as exempt surplus, is it sufficient for Country B to enter into a TIEA with Canada, or do both Country A and Country B have to enter into TIEAs with Canada in both of the above situations?
CRA Response
In order for income from an active business carried on by a foreign affiliate to be included its "exempt earnings" as that term is defined in subsection 5907(1) of the Regulations the relevant affiliate must be resident in a designated treaty country and the active business must be carried on in a designated treaty country.
The March 12, 2009 amendments to subsection 5907(11) of the Regulations provide that, for the purposes of Part LIX of the Regulations, a designated treaty country for a taxation year of a foreign affiliate of a corporation resident in Canada, includes a sovereign state or other jurisdiction if Canada has entered into a TIEA in respect of that sovereign state or other jurisdiction.
The amendment expands the definition of "designated treaty country" in subsection 5907(11) of the Regulations to include countries with which Canada has entered into a TIEA. It does not change the requirement that in order for income from an active business carried on by a foreign affiliate to qualify as "exempt earnings", the affiliate must be resident in a designated treaty country under common law and the active business must be carried on by it in a designated treaty country.
1. Given the above comments, assuming that neither Country A nor Country B has entered into a tax treaty with Canada, it is our view that in the first example in order for the income from the active business to qualify as "exempt earnings", it would be necessary for Canada to have a TIEA with both Country A, where the foreign affiliate is resident under common law tests, and Country B where the business is carried on.
2. In the second example the income of that foreign affiliate from its active business would be included in its exempt surplus if Country B has a TIEA with Canada. It is irrelevant in which country the foreign affiliate is incorporated.
Shelley Lewis
2009-031664
May 1, 2009