Commentary on October 24, 2012 Notice of Ways and Means Motion Relating to Tax Matters - Foreign Tax Credit Generators

Nov 1, 2012

The Notice of Ways and Means Motion (NWMM) re-introduces the August 27, 2010 Proposals originally announced in the 2010 Federal Budget denying, in certain circumstances, direct or indirect credits for foreign taxes on income earned via a partnership or a foreign affiliate.

The 2010 Budget indicated that these proposals were intended to address “schemes . . . designed to shelter tax otherwise payable in respect of interest income on loans made, indirectly, to foreign corporations.” As developed in the August 27, 2010 Proposals and the NWMM, these proposals have broader application.  

The denial of direct or indirect credit for foreign taxes can apply where a taxpayer directly or indirectly holds shares of a foreign affiliate or an interest in a partnership and for purposes of the taxation law of the foreign jurisdiction imposing tax, the direct or indirect ownership of shares or interest in income of the partnership is less than it is viewed for the purposes of the Act.

The NWMM motion reflects important changes from the August 27, 2010 Proposals.  Some of these changes are positive.  That a foreign jurisdiction imposing taxes in respect of which direct or indirect credit is claimed might characterize differently than Canadian tax law a hybrid instrument issued between Canadian residents or share ownership or entitlement to partnership income in an ownership chain unrelated to the foreign affiliate or partnership in respect of which credit for foreign taxes is sought should not result in denial of the credit under the NWMM, in contrast with the August 27, 2010 Proposals. 

The NWMM also introduce new limitations.  If as part of a series of transactions that includes the earning of FAPI, a “funding affiliate” of the taxpayer or related Canadian resident or “funding partnership,” each as defined, provide funding, other than by way of indebtedness on arm’s length terms and conditions or acquisition of shares, to the particular affiliate of the taxpayer (or a partnership of which the particular affiliate was a member) differences in the ownership of shares or share of partnership income under the foreign and Canadian tax law in respect of such funding affiliate or funding partnership including where applicable, shares held by the related Canadian resident, can result in a denial of indirect foreign tax credits to the taxpayer.  Indirect credits are also denied where shares of a corporation are viewed as being held by the same person under Canadian tax law and the foreign tax law imposing taxes for which indirect credit is claimed, but foreign tax law provides an interest or other deduction for dividends or similar amounts. 

These new provisions introduced in the NWMM apply for taxation years ending after October 24, 2012.  As there are a number of jurisdictions which provide an interest or other form of deduction for certain shares, some Canadian taxpayers could face denial of indirect credit for foreign taxes on foreign affiliates for their current taxation year in circumstances which bear no relationship to the “foreign tax credit generator schemes” originally identified by the Minister in the 2010 Federal Budget.

Taxpayers earning income subject to foreign taxes via a partnership or foreign affiliate should consider the potential application of these rules, as revised in the NWMM. 

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