f(~ Date September 15, 2000 To From Barrie Philp, Partner, International Tax Vancouver 604-691-3383 cc George Denier*, Denis Lacroix*++, Lloyd Heine*, Paul Hickey**, Subject Offshore Company Update This is a cover memo to convey three "technical memoranda" addressing the application of the June 22, 2000 Draft Legislation applicable to offshore trusts and foreign investment entities. These memoranda cover: • • • A general overview of the draft legislation A specific analysis of the applicability of proposed sections94, 94.1 and 94.2 to our existing OC structure An analysis of the applicability of the information reporting requirement in proposed section 233.2(4.1) as it applies for the purposes of 233.2(4) to "similar arrangements" The conclusions set out in these memos rely on the previous conclusions, confirmed by Sirncocks, Isle of Man legal counsel, and Fraser Milner, that: (1) as to proposed section 94, which is applicable only to trusts, the OC is not a trust and that no aspect of the arrangement should constitute a trust; and (2) as to proposed sections 94.1 and 94.2, that the "eligible persons" do not have an "interest" in the OC. As a practical matter, this latter conclusion is further buttressed by the fact that the eligible person has no determinable share of income, so that the proposals would, by: default, require a mark-to-market approach and the eligible person has no interest that has or ever could have a market value in any sense. ~. We have not updated the toolkit as theoretically everything in the toolkit still appears to be correct, but in terms of the applicability to transfers or loans from persons resident in Canada (factually, not deemed resident) to OC, the planning letter is incomplete in that it does not cover the new 233.2(4.1)1(4) information reporting requirement. Page 2 We have also not changed or altered the GAAR discussion in the planning letter. It is probably a matter for debate as to whether the proposed draft legislation makes a GAAR challenge a greater or lesser concern. One could argue, assunting that the legislation is passed; that Parliament has spoken as to exactly what circumstances involving nonresident trusts and FIEs are to be subject to Canadian tax, so that a more general antiavoidance provision should not be applied. In other words, planning to avoid the specific anti-avoidance provision is not a misuse or abuse of the provisions of the Act because Parliament has clearly indicated what is a ntisuse or abuse in this particular context. On the other hand, one could argue that these rules are evidence of Parliament's continuing, or increasing, antipathy towards these types of arrangements. As a practical matter, we do not believe that there is a significant market potential for the OC in the estate planning, asset protection or philanthropy situations previously targetted because of the expanded information reporting requirement. We do believe that there is a continuing market for offshore freezes of Canadian corporations, if a non-resident source of funds for the set-up and maintenance of the OC can be found. However, our focus in marketing the OC for the next 15 months (to 12/31/01) will be on providing a solution to existing offshore trusts and FIEs that will be offside the new rules after 2001 and which have the flexibility built into their constating documents that would perntit a direct transfer to the OC, so as not to fall within the information reporting requirements. Furthermore, we will market this product (other than where we have our own clients who are affected) indirectly through lawyers and financial institutions who have clients with offshore trusts and FIEs that will be offside. (As such, we will revise the toolkit to produce an engagement Jetter, planning letter, etc., that is tailored specifically to this market, but this will essentially be a matter of elimination of extraneous discussion in order to make it more focused and efficient.) With respect to GAAR, our assumption will be that the original planning was valid, on the advice of other professionals, and was determined to be appropriate in the face of GAAR. Our advice will be rendered to the non-resident trustees of a non-resident trust or directors of a non-resident FIE, with no obligations under the Act at the particular time, with respect to the Canadian tax implications of distributing the trust's or FIE's assets to the OC (qua beneficiary of the trust or FIE). We do not think that this transfer or the resulting arrangement should, in and of itself, be subject to any provision of the Act, including GAAR. \~ , You should also be aware and consider that I am recommending on the basis of the foregoing that the National Product Committee should rescind their direction that we Page3 obtain a concurring Fraser Milner opinion on each engagement, which I believe was primarily driven by a concern with GAAR and ensuring that the non-tax legal characterizations and asset protection advice were appropriate under Canadian Jaw, as we have Fraser Milner's original opinion and an Isle of Man legal opinion with respect to the other non-tax legal aspects of the arrangement and do not propose to pursue asset protection candidates. I am also recommending that the foregoing position on GAAR should be referred, by copy of this memorandum and enclosures, to the internal GAAR Committee for their review. If you concur with our conclusions, these memos will go together with the signoff memo to to update the file and we will advise the Local Product Deployment Champions accordingly and commence a new roll-out. OFFSHORE COMPANY OVERVIEW OF PROPOSED NEW SECTIONS 94, 94.1, 94.2 AND SUBSECTION 233.2(4.1) Note: The following is a general summary of the above-noted provisions taken, for the most part, from Canadian Tax Notes. For a discussion of how these new rules impact the Offshore Company plan, see the attached memoranda. Section 94 Proposed subsection 94(3) will deem a non-resident trust, other than an "exempt foreign trust", to be resident in Canada for various purposes of the Income Tax Act, including tax on its worldwide income. Additional amendments will ensure that such trusts having Canadian source income will not be able to have such income taxed instead at nonresident withholding tax rates by maldng distributions to non-resident beneficiaries. The proposed rules will apply if the trust has a "resident contributor" or a "resident beneficiary". Enforcement of these rules will be largely by having a trust's resident contributor or resident beneficiary held jointly and severally liable with the trustee for tax. This and related rules will apply for trust taxation years commencing after 2001. Definitions The draft legislation introduces several new defined terms, including the following. A "contributor" is a person or partnership that has made a "contribution" to the trust. "Contribution" includes transfers or loans and back-to-back transfers and loans. "Arm's length" transfers are specifically excluded, but are narrowly defined (see below). A "resident contributor" is a person who is at that time both resident in Canada and a "contributor" to the trust. The definition excludes individuals (other than trusts) who have not been resident in Canada for a cumulative period of 60 months. "Resident beneficiary" means a person resident in Canada at that time who is a beneficiary of a trust which has a "connected contributor" where the beneficiary's interest in the trust is not solely contingent on the death of an individual who is related to a contributor to the trust. "Connected contributor" means a contributor, including one that no longer exists, other than • ;_ ~ an individual, other than a trust, who was not resident. in Canada for . a cumulative .. period of 60 months Page2 • a person who would not be a contributor if transfers and loans which were made during a "non-resident time" of the person were not taken into account. "Nonresident time" means a particular time at which a person is non-resident, where the contributor was non-resident (or not in existence) throughout the period that began 60 months before the particular time and ends 60 months after the particular time. Where the particular time is before June 23, 2000 or the trust arose as a consequence of the death of the person, the non-resident time begins 18 months before the particular time and ends 60 months thereafter. "Exempt foreign trust" includes trusts established for (1) disabled, non-resident children (2) non-resident children following marriage breakdown (3) charitable trusts (4) foreign mutual fund trusts "Arm's length transfer" requires that it be reasonable to conclude that the reasons for the transfer or loan did not include the relationship between the transferor and any person or partnership that was (1) beneficially interested in the trust (2) a trustee of the trust (3) a person having influence over the operation of the trust or enforcement of terms, or (4) a person having influence over the selection or appointment of any person or partnership in (1) to (3) Arm's length transfer includes: (1) an exchange, including its terms, that the transferor would be willing to carry out if the transferor had dealt at arm's length with the recipient (2) a payment of interest, a dividend, rent or similar return on a transfer in (1) (3) a transfer or Joan in satisfaction of an obligation arising from (1) (4) a transfer or Joan in the ordinary course of business . , (5) a. transfer or Joan where it is reasonable to conclude that none of the reasons for the transfer or Joan was to confer a benefit in respect of the trust on (a) the transferor Page3 (b) a descendant of the transferor (c) any person with whom the transferor or descendant does not deal at arm's length. Deemed transfers of property Property is deemed to be transferred to a trust where (other. than on account of an arm's length transfer) either the fair market value of property increases or a liability or potential liability of the trust decreases (paragraph 94(2)(a)). Under a provision obviously aimed at offshore freezes, property is also deemed to be transferred to a trust where the trust holds property the fair market value of which is derived directly or indirectly from properties held by (paragraph 94(2)(b)), or loaned by a 'transferor' to another person (the "recipient") and it is reasonable to conclude that one of the reasons the property was transferred or loaned to the recipient included the relationship between the transferor and any person that was (1) beneficially interested in the trust (2) a trustee of the trust (3) a person having influence over the operation of the trust or the enforcement of its terms, or (4) a person having influence over the selection or appointment of any person or partnership referred to in (1) to (3). Acquisitions of property as a consequence of death are deemed to be transfers. Guarantees or any financial assistance are considered to be transfers of property. The provision of any service, otherwise than in the capacity of employee or agent, is deemed to be a transfer of property. The acquisition of the following are also considered to be transfers (see paragraph 94(2)(g)): (1) a share of the capital stock of a corporation from the corporation (2) a beneficial interest in the trust (unless it is as a consequence of the disposition of an interest) (3) an interest in a partnership (unless it is as a consequence of the disposition of an interest) (4) indebtedness owing by a corporation, trust or partnership. Page4 The granting of a right (such as an option) to acquire or to be loaned property is considered to be a transfer of property. Extended meanine of contributors If a trust makes a contribution to another trust, that contribution is deemed to have been made jointly by the trust and each contributor of the first trust. A "look-through" rule will deem each member of a partnership (other than limited partners) to have made a contribution, jointly with the partnership, to a trust where the partnership has made a contribution to a trust. If a trust, partnership or a corporation makes a contribution to a trust, and the contribution is made at the direction, or with the concurrence, of another person and it is reasonable to conclude that one of the reasons for the contribution is to enable the other person to avoid joint and several liability in respect of the other trust, the contribution is deemed to be made jointly by the trust, partnership or corporation and the other person. Offshore estate freezes Most offshore estate freezes using non-resident trusts (not caught by existing rules) will be caught by the proposed rules and the non-resident trusts will be deemed to be resident beginning January 1, 2002, principally because of the deemed property transfer rule in proposed paragraph 94(2)(b). It appears that offshore estate freezes using trusts will be very difficult to effect after June 22, 2000 because of the various deemed property transfer rules, such as that in proposed paragraph 94(3)(g). For example, the acquisition of a share will be considered property transferred to the trust by the corporation. As a result of the liability limitation, it may still be practical to employ an offshore estate freeze if the liability can be limited to the frur market value of the growth shares three years following transfer. Immigration trusts and non-resident testamentary trusts It will still be possible to establish 60-month immigration trusts for new residents. For example, the definition of "resident contributor" excludes an individual who has not been resident in Canada for a cumulative period of 60 months. The definition of resident beneficiary requires a "connected contributor" and, again, this definition excludes individuals who are not resident for a cumulative period of 60 months. Proposed paragraph 75(3)(c.2) will, in fact, make it more practical to establish immigration trusts as these will not be subject to the revocable trust rules that deem any income, gain may . or .loss to be the transferor's where, for example, contributed property . . revert .to the transferor. For the same reasons, it will still be possible to establish non-resident testamentary trusts. Page 5 Sections 94.1 and 94.2 ·Foreign Investment Entities The new proposals no longer focus on the tax motives of a taxpayer when considering the investment of funds offshore. Instead, they assume avoidance is the primary goal and now require inclusion in income of the taxpayer for the foreign investment entity's ("FIE") tax year(s) ending in the tax year of the taxpayer of either: • the taxpayer's proportionate share of income (detemilned by formula) earned by a FIE ("income accrual rules"); or • the net increase in the fair market value of a taxpayer's interest in a FIE for the year ("mark-to-market rules"). The income accrual rule applies where a taxpayer has sufficient information (in the Canada Customs and Revenue Agency's (the "CCRA") eyes) to make accurate detemilnations and the taxpayer elects for the provision to apply. Among the several conditions that must be met before one can elect to have the income accrual rules apply, the taxpayer's interest in the FIE must be capital property and the interest must not be a right to acquire shares or an interest in an entity. In addition, the election must be made in the first year that the rules apply to the taxpayer and each preceding year in which the taxpayer held the investment and an election could be made. This election must be filed with a timely filed tax return. Who is caught by the new rules? New section 94.1 applies where a participating interest (a share of the capital stock of a corporation, a beneficial interest in a trust, or an interest in a corporation, a trust, an organization or fund, or rights to acquire any of such interests) is held by a taxpayer in a non-resident entity (essentially a corporation, trust or other entity not resident in Canada). For the provisions in section 94.1 or 94.2 to apply, the non-resident entity must be a FIE at the end of the latest of the entity's tax years ending in the taxpayer's year. By definition a FIE is a non-resident entity (excluding certain trusts) that owns investment property constituting more than 50% of the carrying value of all of its assets. A FIE excludes an exempt interest, which is defined to include (among other limited exceptions) a participating interest in a controlled foreign affiliate (CFA) or property held by a taxpayer in a widely-held public company that is actively traded provided that the entity is listed on a prescribed stock exchange and its principal business was not essentially to earn income from property (though the provisions are so complex that many other situations may be caught inadvertently). Investment property is defined to include an investment in shares, a partnership, trust, other entity, indebtedness (except trade receivables), an annuity, commodities, real estate, resource property, currency, financial derivatives, or an option; interest or right in any of these properties. The definition does not provide any exclusions where these properties relate to or are used in an active business. Page 6 For pu11Joses of determining the carrying value of investment property held by the nonresident entity, look-through rules and GAAP are relevant. (Canadian GAAP applies unless foreign GAAP is substantially similar and the financial statements are received within three months of the taxpayer's year-end.) The look-through rules require any entity having a significant interest in another entity (i.e., 25% or more of votes and value in a COI1Joration, or 25% or more of the value of an interest in a partnership or nondiscretionary trust) to ignore the carrying value of that investment, and deem it instead to own its proportionate share of the carrying value of the underlying assets of the latter entity. A taxpayer who owns a participating interest in a FIE must compute income either by using the mark-to market rule or by electing into the income accrual rules. How is the income inclusion computed? If the taxpayer elects for the income accrual rules to apply, the amount included in the taxpayer's income is generally the taxpayer's proportionate interest in the underlying income of the FIE less a gross-up of the related tax paid by that entity. If a Joss is computed, the taxpayer may deduct that loss to the extent an amount was previously included in income under this provision net of any losses previously deducted. The mark-to-market rules apply to a taxpayer owning a participating interest in a FIE if no election is made for the income accrual rules to apply. The taxpayer must include the positive or negative amount, if any, determined by fonnula which generally represents the increase in the fair market value of the taxpayer's interest in the FIE from the beginning of the year, with adjustments to include the net proceeds for the sale of any interests during the year and to include amounts received from the FIE during the year. Fresh start rules apply so that any gain that accrued before the entity qualified as a FIE is deferred ("deferral amount"). Even taxpayers who own an exempt interest in a controlled foreign affiliate ("CFA") must consider these rules. The changes to the foreign accrual property income ("FAPI") provisions essentially require a CFA to determine whether it owns a participating interest in a FIE. If it does, then the calculation of income under sections 94.1 and 94.2 applies in generally the same manner as to direct interests in a FIE for pU11JOSes of computing FAPI. The taxpayer must consider making the same elections as it would for a direct investment in a FIE. Special elections In limited cases, an election can be made to treat the FIE as a CFA if the taxpayer owns more than 10% of the votes and value of the stock of the FIE, avoiding both the income accrual rules or mark-to-market rules and applying, instead, the FAPI rules - however, there are restrictions to making this _election. ·, Page 7 In applying the mark-to-market rules, the taxpayer may also elect to include a portion of the "deferral amount" in income. In certain cases, there may be an advantage to electing to bring this amount into income early. Other considerations The mark-to-market rules contain tracked interest provJswns which look beyond the entity in which investment is held where it has a right to receive income based on the performance of other property, whether or not owned by the entity. If a taxpayer owns a participating interest in a tracked property, then the mark-to-market rules apply with no option to elect that the income accrual rules apply. Double tax relief Section 94.3 provides some double taxation relief designed to ensure that where a Canadian investor receives income during the year from a FIE, the application of section 94.1 and 94.2 do not tax both the income received and the inclusion amounts determined under those sections. When do the rules take effect? These provisions will apply to the determination of income for Canadian investor taxation years beginning after 2001. As such, they will apply to individuals in calendar 2002, while non-calendar year-end taxpayers will need to anticipate their application for their first taxation year beginning after December 31, 2001. Subsection 233.2(4.1}- New Foreign Reporting Rules In general, under existing section 233.2 of the Act, a person who transferred or loaned property to certain kinds of foreign trusts who have a Canadian resident beneficiary is required to file an annual information return with the CCRA. Form 1141 "Information Return in Respect of Transfers or Loans to a Non-Resident Trust" is used for this purpose. The draft legislation amends the section 233.2 reporting requirements to conform with the comprehensive amendments to new section 94 regarding the taxation of non-resident trusts. In general, reporting will be required whenever a "contribution" has been made by a person resident in Canada to a non-resident trust or to a "similar arrangement" at or before the end of the year. The person must file the information return in respect of the non-resident "trust's" particular taxation year on or before the contributor's filing due date for the taxation year in which the particular trust's taxation year ended. The new reporting requirements apply for taxation years that begin after 2001. "Similar arrangement"-Non-resident entity reporting Un.der the reporting provisions in subsection 233.2(4.1) of the Act, under certain conditions, one must file an information return with respect to any type of arrangement Page 8 where a person has transferred or loaned property to be held under an arrangement governed by foreign laws or to be held by a non-resident entity. A non-resident entity is defined in subsection 94.1(1) to include a corporation or trust that is non-resident at that time or any entity (other than a corporation or trust) organized or governed under the laws of a jurisdiction outside Canada. A person will be required to file an information return with respect to a loan or transfer made under either an arrangement governed by foreign laws or to a non-resident entity not otherwise subject to the rules in section 94 of the Act where: • The transfer or loan would not be an "arm's length transfer", and • The loan or transfer is not solely in exchange for certain types of foreign property such as funds deposited or held outside Canada, a share of capital stock of a foreign company, indebtedness of a non-resident person, and tangible property situated outside Canada. Where these conditions apply to the entity or arrangement (which is not subject to tax under section 94), the person's reporting obligations for this entity will be determined as if: • the transfer was a contribution to which section 94 applied • the entity or arrangement was a trust not resident in Canada • the taxation year of the entity or arrangement was the calendar year. According to the Department of Finance's ("Finance") explanatory notes, the key objective of expanding the reporting net so broadly is so that CCRA auditors can review other or similar types of arrangements and decide for themselves whether or not they agree with the taxpayer that they fall outside the scope of the new rules in section 94. The CCRA will also have the opportunity to use the information it gains to encourage Finance to amend the Jaw to catch any plans that otherwise sidestep the new rules. To Private and Confidential File - Offshore Company Date 28-Aug-00 From cc Subject Barrie Philp Proposed Sections 94, 94.1 and 94.2 Proposed Section 94 Proposed section 94 will deem certain non-resident trusts to be resident in Canada for various purposes of the Income Tax Act, including tax on their worldwide income. Specifically, subsection 94(3), the charging provision of section 94, states the following: "Where a trust .. .is non-resident at the end of a taxation year of the trust and, at any time, there is a resident contributor to the trust or a resident beneficiary under the trust ... "(emphasis added). There is nothing in the proposed legislation which deems an entity which is not legally a trust to be a trust. Therefore, whether or not proposed section 94 applies to Offshore Company hinges solely on its legal characterization. Offshore Company should be considered an incorporated company under Isle of Man and Canadian law. Generally, in the absence of a trust or agency relationship, a corporation owns its assets in its own right. However, a corporation may act in a fiduciary capacity as a trustee of a trust if property is transferred to the corporation on condition that it hold that property for the benefit of other persons. In the structures that have been put in place, the gift to Offshore Company was not subject to any such condition. We have been advised by legal counsel that Offshore Company is not bound by any fiduciary obligations to anyone. Offshore Company should not be considered a trustee of a trust of any kind whatever. It is also possible, in certain circumstances, that the shareholders or directors of Offshore Company could be viewed as the trustees of a trust, the assets of which consist of the shares of Offshore company and the beneficiaries of which consist of the eligible persons. This is a question of legal form and substance. In the structures which are now in place, no fiduciary undertakings were required of, or given by, the shareholders or directors. The transfer of property to Offshore Company is an unconditional gift to Offshore Company for its own use. We have been advised by legal counsel that neither the shareholders nor the directors will be bound by any fiduciary obligations to the eligible persons and the eligible persons will not have any enforceable rights, whether in accordance with trust law or otherwise, vis a vis the shareholders or the directors. Thus, neither the shareholders nor the directors should be considered a trustee of a trust of any kind whatever. Page 2 Therefore, proposed section 94 will not apply to Offshore Company. Proposed Sections 94.1 and 94.2 The new rules contained in sections 94.1 and 94.2 generally apply only to a "participating interest" in a foreign entity that is a "foreign investment entity". "Participating interest" in an entity means (a) where the entity is a corporation, (i) (ii) a share of the capital stock of the corporation, and a right to acquire a share of the capital stock of the corporation; (b) where the entity is a trust, (i) (ii) a beneficial interest in the trust, and a right to acquire a beneficial interest in the trust, and (c) in any other case, an interest in the entity or a right to acquire an interest in the entity. The term "interest" is not defined for purposes of sections 94.1 and 94.2. Black's Law Dictionary, Fifth Edition, defines interest as "the most general term that can be employed to denote a right, claim, title or legal share in something." Since the Offshore Company is a corporation at law, neither the non-shareholder member nor the eligible persons have a "participating interest" since they do not own shares of the capital stock of Offshore Company nor do they own a right to acquire any such shares. As discussed above, Offshore Company is not a trust. Furthermore, since it is a corporation under Isle of Man Jaw, paragraph (c) above would not apply by virtue of the words "in any other case". Date To From September 29, 2000 Offshore Company Tax File Banie Philp, Partner, International Tax Vancouver 604-691-3383 cc Subject Proposed Subsections 233.2(4.1)- Annual or One-time Filing Requirement? The general application of the subject provision to the OC is addressed in a separate memo. This memo addresses only the question of whether or not the information return filing requirement applies only in the year of a transfer or loan to the entity or arrangement, or in each year after the transfer is made. The requirement to file the information return turns on the fiction created by the postamble to subsection (4.1) which reads, in pertinent part, as follows: " ... the person's obligations under subsection (4) ... shall be determined as if the transfer were a contribution to which paragraph (4)(a) applied, the entity or arrangement were a trust not resident in Canada throughout the calendar year that includes that time and the taxation year of the entity or arrangement were that calendar year. " The reference to "that time" in the foregoing, is clearly a reference specifically to the time that property is loaned or transferred as set out in the opening words of paragraph (4.l)(a): "[Where] (a) property is at any time ... transferred or loaned by a person .... " Thus, the question arises as to whether or not subsection (4) is only to be applied in the year of transfer because the second fiction in the postamb1e to subsection (4.1) says that the entity or arrangement is to be treated "as if' it "were a trust not resident in Canada" only in the year that the property is transferred, because it is only that year that includes "that time"; or does this fiction create an obligation to keep filing annual information returns, as would be the case for an actual non-resident trust?. Page 2 It has been argued that there is no obligation to file the information return under subsection (4 ), in any year other than the year in which property is transferred or loaned to the subsection (4.1) entity or arrangement, simply because there is no "particular trust" as that term is used throughout subsection (4), except by virtue of the second fiction referred to above, because that is the only part of the provision that says that an entity or arrangement that is not a trust is to be treated as if it is a trust. For the reasons that immediately follow, this argument does not appear to be conclusive, but this memorandum comes to the conclusion that there is only a one-time obligation to file the information return for other reasons set out later below. Arguments for Annual Filing First, it should be noted that the first fiction created by the postamble to subsection (4.1) is that the transferor's obligations are to be determined "as if the transfer were a contribution to which paragraph (4)(a) applied". This latter charge appears to be absolute, irrespective of time. Arguably, ifthis obligation is only intended to apply in the year of the transfer, the draftsman would have said, as if the transfer is a contribution to which paragraph (4)(a) applies, the entity or arrangement is a trust not resident in Canada throughout the calendar year that includes that time and the taxation year of the entity or arrangement is that calendar year Second, if the opening words of paragraph (4.l)(a) are read together with the first fiction in the postarnble to subsection (4.1), it also appears, arguably, that the intent is not necessarily to confine the obligations to the year of transfer: "[Where] (a) property is at any time ... transferred or loaned by a person ... the person's obligations under subsection (4) ... shall be determined as if the transfer were a contribution to which paragraph (4)(a) applied." [emphasis added] Again, if it had been intended that this obligation was only to apply in the year of transfer, the draftsman could have said something along the lines of: Where property is transferred or loaned by a person in a particular taxation year ... the person's obligations ... in that year ... Arguably, the use of the plus perfect and past tense in requiring the transferor's obligations to be determined "as if the transfer were a contribution to which paragraph (4)(a) applied", is intended to obligate the transferor thereafter. Page3 Since subsection (4)(a) applies where "a contribution has been made by a person to a particular trust", it appears that the requirement to determine the obligations of a person who makes a transfer to another type of entity or arrangement, "as if the transfer were a contribution to which paragraph (4)(a) applied", may itself carry with it the obligation, without deeming the entity or arrangement to be a "particular trust", to treat the particular entity or arrangement as if it were a "particular trust", as subsection (4) in its entirety only applies to transfers to such "a particular trust". If the entity is actually a trust, paragraph (4)(a) applies: "{Where} (a) a contribution has been made ... at any time in a taxation year of a trust or in a preceding taxation year, ... ". [emphasis added] Strictly speaking, the underlined words don't have any relevance in the application of subsection (4.1) because the conditions in paragraph (4)(a) are effectively deemed to have been met where the conditions in (4.1) (a) to (e) are met. In other words, if the conditions in paragraphs (4.1) (a) to (e) are met, in applying subsection (4), you move on to test whether or not the conditions in paragraphs (4) (b) and (c) are met. However, in interpreting the application of subsection (4.1), it is important to note that, at least in the case of an actual non-resident trust, the draftsman clearly intended this reporting requirement to be an annual obligation if the conditions in paragraphs (4)(b) and (c) are met. Arguably, this supports the interpretation that the intended application of the first fiction in the postamble to subsection (4.1) is to require subsection (4)(a), which is to be treated as if it applies absolutely, regardless of timing considerations, to apply in a particular year even where the contribution was in a preceding year. Arguments For One-Time Filing The second fiction created by the postamble to subsection (4.1) is " ... the person's obligations under subsection (4) ... shall be determined as if ... the entity or arrangement were a trust not resident in Canada throughout the calendar year that includes that time ... " As suggested above, the absolute obligation in the first fiction in the postamble to subsection (4.1) is to apply paragraph (4)(a) and this arguably carries with it the assumption that the entity or arrangement is to be treated as if it is "a particular trust", so that arguably the purpose of the second fiction in the postamble to subsection (4.1) is not to deem the entity or arrangement to be "a particular trust". Also as noted above, this second fiction is not pertinent to the conditions of paragraph (4)(a) being met. These conditions are met if the conditions of paragraphs (4.l)(a) to (e) are met where property is transferred or loaned "at any time". Page4 Within the context of paragraph (4)(a) regardless of whether or not its specific conditions are met, clearly the purpose of the second fiction is somewhat narrower than generally supporting the application of subsection (4) as it refers throughout to "a particular trust" (which the first fiction arguably does), and that is, specifically, to deem the "particular trust" contemplated under subsection (4) to be: "a trust not resident in Canada throughout the calendar year that includes that time" If the first fiction creates an obligation to apply all of the provisions of subsection (4) as if the entity or arrangement is "a particular trust", it is arguable that this second fiction is directly relevant only to the test in paragraph (4)(c), and indirectly, by reference in the third fiction, to the test in paragraph (4)(b). The conditions in paragraphs (4)(c) and (b) are ambulatory conditions that are clearly intended to be tested each year; otherwise, there would be a perpetual obligation to file. As has already been noted, the reference to "that time" in the second fiction is clearly to the time at which the property is transferred or loaned. Thus, in the case of paragraph (4)(c), the "particular trust" referred to in paragraph (4)(c) is only deemed to be "a trust not resident in Canada throughout the calendar year that includes" the time at which the property is transferred or loaned to the entity or arrangement. If the first fiction carries with it the notion that the entity or arrangement referred to in subsection (4.1) is also to be treated as if it is "a particular trust", this is not, in and of itself, sufficient to make the entity or arrangement a trust that is a non-resident of Canada. Furthermore, a requirement to look to the actual residence of the particular entity or arrangement for the purposes of paragraph (4)(c) would have to be set out in express language, and subsection (4.1) is clearly intended to apply to entities or arrangements in respect of which residence may not be a relevant concept or capable of being determined, e.g., a partnership or a contractual arrangement. The third fiction in the postamble to subsection (4.1) is that: "the taxation year of the entity or arrangement were that calendar year" This third fiction is also necessary to applying the test in paragraph (4)(c) (and paragraph (4)(b), as addressed below. Its time reference is not directly to the time at which the property is transferred or loaned, but its reference to "that calendar year" is a reference to the words "the calendar year that includes that time" in the second fiction. However, again, "that time" refers back to the time at which the property is transferred or loaned. The paragraph (4)(c) test clearly can only be applied if the entity has a taxation year. Thus, the third fiction is necessary to determining the time at which one tests under Page 5 paragraph (4)(c) to see if the "particular trust" is not resident in Canada. Again, it might be argued that this provision is not necessary on the basis that one could look to the actual fiscal period of the particular entity or arrangement, but such a fiscal period is not a "taxation year" except in the case of cmporations and individuals (S.249(1)) and subsection (4.1) is clearly intended to apply to entities and arrangements, e.g., partnerships and contractual arrangements, that otherwise would not have fiscal periods or taxation years as defined under the Income Tax Act. The paragraph (4)(b) test also clearly can only be applied if the entity has a taxation year. Thus, the third fiction is not only necessary to determining the time at which one tests under paragraph (4)(c) to see if the "particular trust" is not resident in Canada, but it is also a necessary fiction to determine the time at which to test whether or not the person who made the transfer or Joan to the entity or arrangement is a resident of Canada, under subparagraph (4)(b)(ii), and the time at which to test whether or not the entity or arrangement is one of the excluded types of entities or arrangements, under subparagraph (4)(b)(ii). Summary and Conclusions In summary, establishing a person's obligations on the basis that paragraph (4)(a) applies regardless of when a transfer or loan is made to the entity or arrangement appears to imply that you go on to test paragraphs (4)(b) and (c) as if there is "a particular trust" which meets the conditions of paragraph (4)(a); but that, in and of itself, is not sufficient to make the entity or arrangement a person that is a non-resident of Canada (or, indeed, in respect of which residence can be determined, e.g., a partnership or a contractual arrangement) or that has a taxation year. Based on the plain words of the second fiction created by the postamble to subsection (4.1) it appears to be clear that the tests in paragraphs (4)(b) and (c) are only intended to be met once, in the calendar year in which a transfer or loan of property is made to an entity or arrangement that meets the conditions in paragraphs (4.l)(a) to (e). Policy Perspective This conclusion appears to make sense from a policy perspective as well. In the case of an actual non-resident trust, annual filing, until one or the other of the conditions in paragraphs (4)(b) or (c) are not met, makes sense because the non-resident trust may not have a tax obligation in a particular year, but may in a subsequent year. It would seem reasonable that the Department of Finance would intend that CCRA be reminded of the existence of the trust and be able to review its liability to tax every year, particularly in light of the fact that trusts are not otherwise obliged to file tax returns for Page6 a particular year unless they have taxable income or capital gains, and may eliminate their income by distributions, which might not be reported, to taxable resident beneficiaries. l-'l ., On the other hand, it makes no practical sense to oblige a contributor to another type of entity or arrangement in respect of which an information return has been filed by the filing due-date following the year of transfer or loan, presuming that it has not been determined on the basis of that filing that the entity or arrangement is a trust subject to section 94 or a FIE subject to sections 94.1 or 94.2, to continue to file an information return in each subsequent year that would have no additional information value with respect to a potential tax obligation. This would be an onerous and unwarranted burden on both the transferor and the CCRA and presumably would run a great risk of a Constitutional challenge on the basis of the Privacy provisions, since its ongoing requirement and potential penalties for failure to file would have no basis in enforcement of the provisions of the Income Tax Act. :_ ~ ( :Jt-\0.'\..\.i.::·.i f c"""' --\v.;H.'\S.C t~f\1-Vv-. DL ~ t . .::\1 \::::;-,.,,).. " c ~ \;(1-(L- 1~\.~~l \Hiclts in ;.1 ft•lt compelled to legislate to Some jurisdit:tions. which have traditionally helonged to the English t•quitahh~ tradition. then felt it nl!t:essilry to n>spoml to the llt..~V statutory fonm. omd d~t:idt>U to coW~· their equitable tmst law. ;t prn<.Tdnrl' fraught with danger and prol1lc·ms. Some of these jurisclil·tions lt:.l\'l' Jlt:.lllo.tl!.ecl to do so without dama~mg the fundaml!ntal concepts of equity. Others. hmv~\'f"r. have not been so skilful. ami la;tve- t•ffectively destroye(l the l'sign. Tht'rt' is no pre·Uetermined capit.1l omd 110 set number of memben. l11e uuupan~· hut onk on the nomination of a IOunUer h rec:tor. to hold onice for one ~-ear before m•t'dint.!. rL•-elt't·tinni. It is the ordinary direl1ors who actua.l.ly nm the l(mntbtion. "11h the founder directors al'ting like the 'dons of most weulthy f;.tmilies. that is. only interfering when something raises funds from subseriptions uf tlisplt·a.~es them. members. There may he an t•ntn· suhscription pi!yable by~~ new llll'lllht"r. In what jurisdic:tions. then.t.:an one lind l.tw SHitahle for establishing ;.t common l.1\\' linmdo.1tion? Any jurisdiction which pl'rmits companies limited hy gmmmtee can l)t' used. althou~h !iome j11risdietinns .1re hrtter than uther.i. Fur t-x;.unple. the Ht•tmhlit.· of lrelmul takes the \it•w that otll :_!uarantee c.:ompani<•s arc. hy definition. pnl,lic eompanies. since they L·aunot n·striet tl1c tr.msl~mbilitY ,,r tlwir slmres. of whidl they have none - a \'t·~· Irish .tpprnach! Equally. the United Kingdom \1;~ alxJ!isliL-cl the l1yiJrid form tJft'On,puny 'wilids t:un he VNY useful for eompk·x fotnulttioml. ;aml does not [>l'nnit t.L"X uunn•o.;itlent't." for t.·ompallit~s. Tl1c <.:l.anlw1 Islands have \"(•rv rt"s-trictin· law for ~tntromtt>l" t·nmpnnies. ami this gr(';atl~· 'li minislit•S" thl" usefulnc:ss of the !-,'lliW..IIIh.:·t.• t·mnpany there. :\member is elected into membership. and. in consequence. ~uarantt't>!'> tlw liabilities of the eompany to the t'xh·nt or a nominal sum. for e:\ample. GB£lO.OIJ. l l \ l I ' ~ I' ~ r ~~, Ji ;md there may he an annuul suhst:ription. Thf' amounts. and the persons liahlt· to pa~·· muy be pntirely il matter for tilt• tliscrt'tion the dirf"t·tors. There lllilV lw differt•nt classe!i of memht•rs. Snuw members may h;.tvc all the voting nt!hts. or Some member~ may h:1Vf' taconomlt' particip;1tion rights. while other uw1nbt~rs mav have none. If we are stmcturin~ the t:nmpom~· a" a foundation. the t·omaitution would stipulate who can ;mcl whu eunnnt bPJWfit from the fcmnclation. In il!i simplt'!il li~r~u. thert' wnltlcl he only ont• or two nu••nl)('r . . nfthe t·mnpm1y. llt~ithN IJfwhcunl~;ul a11\· ri)'!;hts to bcm~·fit from the fonndalion. ln1l whmt- sole rights. like thad oftlu·linmdt·r of a stiftun~. would be to 11ppoint tlw direetors. ami J!:enemlly tn !'illpt'n,sr· the ac.:thities ()r the li:ntndatic,,,, The first frmndcr membN mjc·ets tlw ;Js!wls as his initial !illbst·ription. Tlw liuuult·r·s rights thus t•nun~ to tilt' li11nnlc·r memiH"r or mcml~r.; I(Jr rlu: til_m·lwlllc.. A itmJ1Jcr member c-•.m nmninutt• oultlllu·r to rl'phll'e him. and the new mPmlwr tln·n takes over the baton frnwn thr. nmniuatlln.! limmlt~r rnemher. The JUumlation is ;u..1ually nm h\· tlw tliret:tors. who c-.mnot benefit eithl'r. ( Jul~· those persons and (or) purpnst""~ designated in the constitution of tlw foundation c-.m benefit. as provided in tiH' constitution. The foundation can be made much more complicated. TI1ere can be rwo inr t immenselv Oexible. simple to nperdte. and thus inexpensive. It can he cl~astic. a1u..l is not subject to the rules u~ainst perp~?tuities amlin unstalt nr <•stnblislunent. Tlte nosrxmsibilities nf the tlirectof1i . their addn:sses. ·occupation and number of shares held; naJ~~CS of shareholder> ceasing to hold sham;; and the names and addresses of directors and the company secJCtar)'. By contrast. none of this information is - To be registered as an exempted company, the memorandum must state that its objects ix) may (but need not) end in ""IBC" or International Business Company": · iv) e~cmpted companies may not offer their shans for ,.le in the Turks and Caicos Islands. whereas ordinary companies may do so. subject to filing a Prospectus; an ordinary company must include guarantee. An exempted company may. under s.l90A. also elect to have this secnon apply to 11. Such a company is known as a hybrid company. which should not be confused with a hybrid company incorporated under No\-""3 Scotia law. Hybrid companies existed under English Jaw up until quite recently. Hvbrid companies. of the type allowed by the Ordinance. are unknown to Nonh American corporate and tax law. In the hybrid company situation. the shareholders and directors control the company. They are not nominees for the benefiCial 0\\."ller. In this way. mind management and control would clearly reside outside of Canada. The AnicJes of a hybrid company do not entitle the shareholders to :my income or capital. Due to the unique characteristics of a hybrid company. the shareholders m:~y distribute income or cD.pital or both to the guarantors or to third panics who are not members of the company. In making such distributions. the shareholders need n01 maintain an even hand and may pr~fer one recipient over another. A hybrid comp.any has many of the characteristics of a trust. The hybrid company is not. however. a trust (80\nm \'. St'cular Sucien· (19171 A. C. 4061. This is impor· tan1 b~cause it determines what law applies to govern its operation and h:lS consequences from a Canadian tax point of view. rcqu1rcd to be included in the annual return filed by an exempted company: C.\cmptcd company may have par ..·alue 01nd no par value shares: .\ 1 an The An1cles of Association may restrict totallv the transfer of shares or may limit such .transfer to circumslilnccs of :::1pproval by resoluuon of the members . An LLC need not have a director and sccre- only an exempted company may apply to be registered as a limited life company; ."i:l) xiiJ special confidentiality rules apply exempted companies: and 10 x.iii) an exempted company need not maintain a register of mongagcs or a register of directors. Limited lift companies An exempted company may, under Pan VII lA) of the Ordinance, apply to be registered as a Limited Life Company (s.I98A). Such companies must have at least 2 subscribers; a life limited to SO years 1150 years if a resolution is passed pursuant to s.I98C. and must end in the words .. Limited Life Company" or "LLC". ,, larv ts.l98 0(3}) and may may have anicles wh.ich specify that upon the happening of a cenam event. a person ceases to be a member (s. 19810)21. Most 1mponantly. a limited life company shall automatically and without funher acnon be wound up as and when the period for duration expires or upon lhe happening of cenain events (s.I98E). It is this provi· sJon which gives the LLC cenain tax advantages for US Citizens. Under US tax law. the profits of an LLC.flow through the company without attracting tax. Hybrid Co~panies Under the provisions of s. 7(2) of the Ordinance, an ordinary company may be incorpomled in which the members have share capital but their liability is limited by Trusts. under Canadian tax law. are subject to special laws which determine tax liabiiitv for both the trust it~elf and for the senior ;nd beneficiaries. A company. on the other hand. will be taxable in C.:m:ula if it is resident in Canada. The test for a company is to determine where the mind management and control reside. If a corporation is not resident in Canada. the Foreign Accrual Propeny Income ("FAPI"l rules in ss. 90 to 95 of the I11c-ome Tu...'C Ac-1 m01y apply. In the case of a hybrid company. these provisions have no applicatiOn. The taxpayer 1who may be a complete str.:mger to the compa~ ny) does not in fact own any shares in the hybrid company (s.9HI) ofthelncome Tax and the company is not a controlled foreign affiliate of the taxpayer ts.95(1) of the Income Tax Act). Arguably, the taxpayer has no .. interest.. in the hybrid company as that e>:.pression is used in s.94. I of the Jncom~·rax Act. The unique chanctcristics of hybrid companies also have significant advantages for U.S. citizens. Act). Confidentiality The Confidential Relalionship Ordinance }979, as·amcnded. prohibits tht disdosurc July/A~USI 1998 TEMPLE TRUST Th~ largett fullnrvice, Jicenud and ~istend trust company in thr Turks 6: Caicos Islands. lncorpor~ted tn 1985, fully insund ~:nd audited annually. 011T mmplC'lt" rnngr of finmlrinl. '"·orpnrntr. im'l'l;tmmt and lrllst :;~n·icr:- mcludt•: Trust.fonnatinn tt11d at;sd mnnogL'IIIt'11f m: lin•uSC'd Trut;h'i' • Compan~ incory>oration ami a,tminiMral/011 • Ctll~/idrutiDI f;t'Lurilirs traJin.~ wit/1 Jin'Ct aCC("55- to all1W1111r nmrkt'ts thmusll Trmplr SC'cuntit:r; Ltd.·· Compll'tr rans" of o_if:ohor,- rrmtwlllum1:;. azwilabll' • Mortgn,~r lmdins. im~Ntml'nl o11d illllll 11umngrml'lll. through Trmpli• M,lrtsngc Corp11rntinn Lilt. Tr:nrplr Twst Compan_11 Ltd.: P.O. Box uS. Tt·mplr Buildi"S· Ltttvnrd Hu>y.• Pmvid;11cinlr:s. Tinks & Cnic(J:;. J~lnnds. BWI Tl'l: 6t~9 946 5i40 • f•1:r: b49 946 57)9 E·mnil: lcmplrtr~!lciway.tc of confidential information with respect to businesses of a professional nature which arise in or are brought into the Islands. This Ordinance applies to all persons who come into possessiOn of such information at any time afl(:r such businesses are commenced or brought mro the Islands. ··confidcnuill infonnation·· is defined as mcludmg information concerning any propeny or relating to an)' business of a professional nature or commercial U&~.nsac· uon which has taken place or Is contemplated. ··Business of a professional nature" is defined to include the relationship between J professional person and his or her principal and the relationship between a bank and ns customer. - "'Professional person'' includes an accountant. anorney, broker, commercial agent, oadviser. bank. financial institution. pub Iic officer. government official or employee. and includes any person subordinate to or in the employment of or under the control of such persons. .The Ordinance creates offences for wrongfully disclosing or using confidential information. There are. however. cenairi excep. JulviAu\)un 199e uon!i to the protection afforded by the Ordmance· 11 the pnncrpoal may expressly or impliedly ,. . aJVc rhe prorccrion: 11 1 the rna I of a person 1n respect of an alleged md1ctable office; ui 1 m!onnJIJOn rcce1ved by a police officer m rhc course of a cnminnl invesllg&~tion: 1v 1 rhc l\1mister of Finance under The Bunk~ng UniinancC'. indirectly to the imposition. calculation or collection of taxes and unless the requesting authoriry 1s subject 10 adequate restrictions on funher disclosure. Prorecred tell c:ompanirs Currently no legislation is proposed 10 J!low for the creation of protected cell com· pames. Conclusion Compant~s Ordinance contains specif· ic confidcnt1ali1y rules applicable to e~empted compames. While having similar Jcfin111ons and scope, the Ordinance pro' 1des rhat whenever a person intends or is rcqu1red to g1ve evidence at a trial in which an e,.;:empred company is a pany. he or she shall apply ro the Supreme Coun for direcrions. A Judge of the Coun will detcnnine if the e\IJdence shall be given or not. Penalnes are created for failure to comply wuh rhe Ordinance. The Cenain laws. such as the BanK Acl Ordinance. contain provisions known as gateway legislation. This allows the disclo-sure of otherwise confidential information if requested by an overseas regulatory authority. Such a request will not be complied with. however, if it relates, directly or The Turks and Coaicos Islands by reason of i1s stable government. history of common law justice. lack of taxation and up to date company legislation. offers a convenient. reliable and safe jurisdiction in which to conduct personal and international business affairs for financial, estate and tax planning purposes. • Brion Trowbridge obtained hi$ low Jeg,ft. from thr University of Brilish Columbia in 1974 and H'Q.t called to the Bar of Briti.fh Columbia in Mav 1975. Brion M'U.S odmilled ro the Turtr a~d Coico.f Island$ Baf. in Sept~m~ /99~. He proclius in the afWIS of e.srate law. compony and rommrtriDI lllM\ immigration. trusu and securiti~s. Brian may be reached in Providenciale.t h,v Ieleplzollt at (649} 946-4261. Tf'DI English Bulletins, Circulars and Rulings Page 1 Query=share IT-392 Meaning of the term "share" September 26, 1977 Reference: Section 91 (also sections 92, 93 and 95 and Part LIX of the Income Tax Regulations) I. This bulletin discusses the meaning to be attributed to the term "share" for the purposes of the Foreign Accrual Property Income provisions of the Act. 2. Share is defined in subsection 248(1) to mean "a share or fraction thereof of the capital stock of a corporation", which is the traditional concept recognized not only in Canadian law but also in many foreign jurisdictions. 3. In those instances in which the ownership ofa foreign business entity is not divided into units entitled "shares", and in which the foreign business entity is considered to be a corporation, the Department views the foreign business entity as if it has a capital stock of I 00 issued shares. Each owner of a beneficial interest in the foreign business entity is then considered to own a number of shares proportionate to his beneficial interest in the foreign business entity. If, for example, a German GmbH Shareholder A has a share of DM 200,000, Shareholder B has a share of DM 200,000 and Shareholder C has a share of DM 400,000 the Department would consider that the shareholdings were as follows: Shareholder A 25 shares, Shareholder B 25 shares, Shareholder C 50 shares. 4. Interpretation Bulletin IT-343R discusses the Department's view of the meaning of "corporation" for the purposes of the Foreign Accrual Property Income provisions of the Act. In those instances where the Department considers that foreign business entities are corporations it also considers that the ownership of foreign business entities is divided into shares. May 1999 Release © 1999 CCH Canadian Limited English Bulletins, Circulars and Rulings Page 1 Ouery=share IT-343R Meaning of the term corporation September 26, 19n Reference: Paragraph 95(1 )(d) This Bulletin cancels and replaces Interpretation Bulletin JT-343 dated September 7, 1976. I. For the purpose of subdivision i of Division B of Par1 I of the Income Tax Act a "foreign affiliate" is defined in paragraph 95(l)(d) as being a non-resident corporation in which the taxpayer's equity percentage is not less than.IO%. The purpose of this bulletin is to define the term "corporation" as it applies to that paragraph. 2. A corporation is an entity created by law having a legal personality and existence separate and distinct from the personality and existence of those who caused its creation or those who own it. A corporation possesses its own capacity to acquire rights and to assume liabilities, and any rights acquired or liabilities assumed by it are not the rights or liabilities of those who control or own it. As long as an entity has such separate identity and existence, the Depar1ment will consider such entity to be a corporation even though under some circumstances or for some purposes the law may ignore some facet of its separate existence or identity. 3. It is the view of the Depar1ment that the above definition includes not only corporations sometimes referred to as joint stock companies and limited liability companies but also the following entities organized under the laws of foreign jurisdictions: Aksjeselskap {A/S or A.S.) {Norway) Aktieselskab {A/S) {Denmark) Aktiebolag {Sweden) Aktiengesellschaft {A.G.) Anpartsselskab tApS) {Denmark) Anstalt {Liechtenstein) Besloten Vennootschap met beperkte aansprakelijkheid (B.V.) (Netherlands and possessions) Campania An6nima Gesellschaft mit beschrankter Haftung {G.m.b.H. or Ges m.b.H.) Kabushiki Kaisha {K.K.) {Japan) Limitada {Sociedade por quotas) {Portugal) Naamloze Vennootschap {N.V.) {Netherlands and possessions) Sharikat Al-Mossahamah (Saudi Arabia) Sharikat Mussahama Sherkat Sahami Aam {Iran) Sherkat Sahami Khas {Iran) Sociedad(e) (s) an6nima {s) (S .A.) Sociedad(e) (an6nima) de responsabilid(e) (ad) limitada (por quotas) (S.L.) (S.A.R.L.) (SRL) May 1999 Release © 1999 CCH Canadian Limited English Bulletins, Circulars and Rulings Page 2 Ouery=share Societe anonyme Societe de personnes Soci€t€ a a responsabilite lirnit€e responsabilit€ lirnit€e Societa per Azioni (Italy) Yugen Kaisha (Japan) Many of the above entities exist in more than one country. Those which the Department recognizes in respect of one country only are identified by the name of the country in brackets. 4. The Department may be consulted in respect of the status of foreign entities not included in the list in 3 of this bulletin. May 1999 Release © 1999 CCH Canadian Limited - TaxFind · Publications The foreign entity will have to be considered, for Canadian tax purposes, as a "corporation" in order to avail itself of the foreign affiliate rules. ln paragraph 2 of Interpretation Bulletin IT-343R ··,dated September 26, 1977, Revenue Canada takes the position that [a) corporation is an entity created by Jaw having a legal personality and existence separate and distinct from the personality and existence of those who caused its creation or those who own it. A corporation possesses its own capacity to acquire rights and to assume liabilities, and any rights acquired or liabilities assumed by it are not the rights or liabilities of those who control or own it. As long as an entity has such separate identity and existence, the Department will consider such entity to be a corporation even though under some circumstances or for some purposes the Jaw may ignore some facet of its separate existence or identity. ©Canadian Tax Foundation -1999 KPMG LLP PRIVATE_&_CONF1DENTIAL_OPTIONAL Date February 2, 2000 To From Barrie Philp Vancouver (604) 691-3383 cc Paul Hickey, Denis Lacroix, Karen Aziz, George Denier, Lloyd Heine, SubJect Offshore Company- 95(6)- Your Memo of January 17,2000 1 am attaching memo on this subject. You will note that he is in agreement with our conclusions in our technical memorandum, albeit for somewhat different reasons (and with considerably more brevity). However, I want to respond to the specific issues raised in your memo. First, as a general reaction I think you may be giving insufficient weight to the consistent use of the same words in so many places in the Act where clearly there can be no argument that these words refer only to something less than full beneficial ownership, as it would appear to be very difficult for a court to give a different interpretation to the use of the same words in 95(6). The purpose of such provisions appears to be very similar, i.e., to deem a person (and only such a person) who has legal rights in shares to own them. Obviously, it would be a tautology and redundant to refer to a person who owns shares as having "a right to shares"; and these words clearly do not encompass ownership of shares in any other provision of the Act, so how can the same words do so in 95(6)? I would also be interested in how you reconcile the fact that any other interpretation puts 96(6)(a) in conflict with 95(6)(b) in certain circumstances, as set out in our technical memo. That said, to your specific points: I. I believe when you refer to "an accommodating party" you are being a bit loose with the language in that you are really inferring that the holder of the shares is acting on the direction of someone else and thus has something less than full beneficial ownership, e.g., has an agency relationship, or is a nominee, or the purported ownership is a sham, which could be challenged on general principles without resort to 95(6)(a). I believe that 95(6)(a) is intended to apply where the legal substance is that the holder of the DDOD C~na.do~n KPMG UP. a owned. limited liability partnen;hip utabl;.hed under I he !aWl of Ontario. 11 a member l1rm of KPMG lntematoon..l. ;1 Swon ;uom;iat•on Page 2 shares has full legal ownership, but someone else also has legal rights to or to acquire the shares, to deem the. latter person to own the shares. Under the OC structure, the shareholder holds all legal right, title and interest in the shares (and also has all of the economic interests in the company that are subject to any legally enforceable rights, albeit such participation is limited to Sterling 4000 per annum), is not subject to the control or direction of anyone else, is free to vote the shares and to transfer the shares (subject to the usual private company restrictions), etc. The holder is not "accommodating" anyone else in any sense that can be assimilated to legal rights to those shares. On the other hand, even if the shareholder did not have an economic interest, it still would not be reasonable to conclude that the holder's ownership should be attributed to someone else if the purpose for which the shares are held is to give effect to ("accommodate") the purposes of the company or the founder, assuming that such ownership is not simply disguising the accrual of the true benefits of ownership to that founder or someone else. For example, you may have held shares and units in nonprofit corporations and societies over the years to "accommodate" the achievement of the purposes of the organization. The OC is generally a multi-purpose organization, akin to a private foundation. Generally, the founder will riot benefit from the OC. The Eligible Persons may so benefit, but they have no right to do so, and it cannot be determined who will benefit or, if they will benefit, by what amount. The shareholders, to the extent that their ownership is not entirely driven by their own pecuniary interests (which I would suggest it may be) are "accommodating" the purposes of the OC and the founder, but you would have to be able to maintain that the founder or the Eligible Persons retained or would eventually obtain the benefits of ownership of the shares held by the shareholders or have disguised ownership interests in the company, not just that they might receive some gratuitous benefit from the corporation, which under Isle of Man corporate law the corporation is entitled to bestow. 2. Every provision of the Act, which we believe we exhaustively canvassed in the technical memo, which deems someone other than the beneficial owner of shares to own them, is based on a policy that a person who has rights less than full ownership should in the particular circumstances be treated as if they had full ownership. From a policy perspective, there is no need to encompass full ownership because the consequences that are intended, flow from full ownership. 3. I understand and agree with the notion that a share, indeed all property, can be considered to consist of a bundle of rights. It is a fine grammatical point, but I think a person who holds all of the rights associated Page3 with a share can be said to own or hold those rights, but not to "ha[ ve] ... a right to" those rights. He already "has" those rights. So to say he "has a right to those rights" is a granunatical tautology which I do not think can be presumed of Parliament. One would expect that the situation of full beneficial ownership would in 95(6), as everywhere else in the Act, be referred to by use of the terrn "owns" or "owned". It would not be normal usage, and certainly is not so anywhere else in the Act, to refer to such a person as having "a right to shares". I also refer you to the recent discussion of the nature of shares for tax purposes in an article written by Mitchell Sherman and Carrie Smit of Goodman Phillips & Vineberg in Corporate Finance, titled FIE? FIE?. Ho-Hum ... ,at page 747: It is well accepted tluzt a share constitutes a bundle of rights and privileges taken, in particular, from the terms and conditions set out in the constating documents of the corporation and more generally from the governing corporate law. Notwithstanding the broad definition of "property" for income tax purposes. which includes a right of any kind whatever, it is also well established that transactions involving shares are taxed on a bundled basis. This approach may be supported, as a matter of interpretation, by the specific reference to a share in the definition of property. Administratively, this approach also avoids the many practical difficulties associated with an analysis that is dependent on bifurcation. [Sherman and Smit also cite and discuss IT-448 and Technical Interpretation Document No. 9413775 (September I, 1994) to demonstrate that CCRA's interpretive position is consistent with this approach.] This approach is consistent with the usage of the terms "a right to, or to acquire shares" throughout the Act as a reference to something less than full beneficial ownership where as a policy matter it is desired to put a holder of some one or more rights with respect to shares in the same position as an o·wner of the shares, for purposes of the taxation of transactions involving the shares. In other words, construing "a right to shares" as encompassing the ownership of shares is inconsistent with this bundled approach. reads it, then using the words "right to Finally, if95(6)(a) is read the way shares" to encompass ownership would be redundant because he (and everyone else I have discussed the provision with) is convinced that the reference to "that person" in the postamble to 95(6)(a)(ii) can only be to that person who has the right to the shares, not to the "any person" seeking to reduce income tax referred to in 95(6)(a)(ii). Page4 4. I agree that 95(6) could be interpreted following a "purposive" approach. I realize that you are referring to the purpose of stopping inappropriate tax benefits being obtained by avoiding or creating a foreign affiliate or controlled foreign affiliate relationship, as the case might be. However, I also think that within this context a purposive approach must consider"the policy intent of the usage of such deeming language, as in other provisions of the Act. I think it is well established by usage throughout the Act that the purpose of the language used in 95(6)(a) is to deem persons who have legal rights with respect to shares to own them so that the consequences of taxation, which, as discussed above, always follow the ownership on a bundled rights basis in the case of shares, fall upon a person who has rights which are less than the full bundle of rights in the shares. In other words, I believe that the purposive approach would lead the court to conclude based on consistent usage throughout the Act, that the purpose of this language is to deem someone who has an futerest in the fomi of rights in shares to own them, not to deem someone who has no such rights to own them I do not believe that there is any indication in the Act that the scheme of the Act is, in any circumstance, to tax persons who have no legal rights in shares as if they own them As we have pointed out in the technical memorandum, using a "right to shares" to refer to ownership is also inconsistent with normal usage. In fact, as indicated above, using the term "a right to shares" to mean ownership would appear to be a grammatical tautology, so not correct usage at all. Clearly, the ordinary usage and usage for income tax purposes of "a right to" means that the person doesn't hold or own the thing, but has some type of interest which rises to the level of a legal right in it. For example, someone else has "a right to" a bearer share held by a lawyer. In this case, we might say that that person has "beneficial" ownership. The only thing he doesn't have is title and possession, represented respectively by an entry in a share register and by the share certificate- title and possession being one of the rights in the bundle of rights associated with any property. A person who has subscribed for, but not been allotted shares, might also be said to have a right to the shares. But in normal usage and, I suggest for income tax purposes (based on consistent usage throughout the Act), a person would never be said to have "a right to" something he owns, as that is a grammatical tautology. He would be said to own it. In every other provision of the Act, and thus it would appear a virtual certainty that it would be so construed in 95(6), this is also how the term "a right to shares" is used- never to apply to ownership. 5. I agree that 95(6)(a)(ii)'s reference to "any person" could encompass an Eligible Person and the intent to avoid tax which might otherwise fall on such Eligible Persons. However, I do not agree that 95(6)(a) can be intended to tax a person who has no right to income or capital of the company and may never receive anything from the company. That would be perverse and inconsistent with the scheme of the Act. Generally, the Page5 scheme of the Act is to tax persons who have legal interests wlrich result in income or gain to them, and to tax them when that income or gain is realized. I realize that there are exceptions, e.g., the attribution rules with respect to income on assets transferred or loaned to or for the benefit of spouses, minor children and revocable trusts, but they are very specific exceptions to the general principle. Also, as a general principle, the scheme of the Act is not to continue to tax persons on income or gain from divested assets, except in these limited attribution situations, never mind persons who have no legal rights and never had any legal rights in the property. Thus, I agree with your statement only insofar as the purpose of an Eligible Person avoiding tax might cause 95(6) to apply to deem a person, who has some rights in the shares, to own such shares. Since no one other than the shareholder has any rights in the shares, and they already own the shares, tlris conclusion is of no consequence. For it to be of consequence, you have to read the reference in the postamble to 95(6)(a)(ii) to "that person" as a reference to the "any person'' who is intended to avoid tax, not the person who has the right or interest in the shares, notwithstanding that such person has absolutely no legal rights and may never receive anytlring from the corporation. Although when we first discussed tlris provision, I was inclined to agree that it could be read tlris way, I recant. Tlris theory begs the question of how you would tax, for example, a list of Eligible Persons who have no rights if they were each deemed to own the shares held by the shareholders - full tax on each one based on the assumption that the corporation is a CFA of each one, prorata, or what? In other words, its an unworkable concept, is not reflected in the scheme of the Act and cannot have been intended by 95(6)(a). On the other hand, if it was a single person who divested lrimself assets in favour of the OC and who sought to avoid tax to lrimself or others, there could be some practical merit in the theory that he should be deemed to own the shares and taxed on any distributions from the corporation, or perhaps as if the corporation were a CFA. But if he is never intended to receive any distributions therefrom or to otherwise personally benefit from the shares of the corporation, tlris again would be inconsistent with the general scheme of the Act. Notlring in the Act suggests that a taxpayer should continued to be taxed on the income or gain from assets wlrich he has truly divested lrimself of, except in certain very limited circumstances intended to prevent income splitting. There is no question in the OC case that the founder has truly divested of Iris assets to the OC and as long as he has not substituted other property, e.g., acquired legal rights in the company, he has notlring in respect of wlrich he should be taxed. With respect to the issues being of a legal nature and seeking a legal opinion, we did obtain an independent legal opinion from Fraser Milner. They presumably canvassed all aspects of the strategy from a tax and non-tax legal perspective. Fraser Milner's opinion to us discussed, in section 4.0, particularly at paragraphs 4.4 through 4.9, the meaning of "share" and "shareholder" for purposes of the Act. Fraser Milner opined: Page6 In our opinion no Eligible Person will own shares in Offshore Company merely by reason of being an Eligible Person. Hence Offshore Company cannot be a CFA in respect of any Eligible Person. Further, assuming the Members are not agents for Mr. Smith, as discussed below, Mr. Smith will not own shares in Offshore Company and hence Offshore Company cannot be a CFA in respect of Mr. Smith. I've also reviewed this issue with . to get another lawyer's perspective. He concurs with view set out in the attached memo and our conclusion with respect to the meaning of "a right to shares" for purposes of the Income Tax Act., including 95(6). I appreciate you putting our feet to the fire on this issue, but with this, I believe that we have gone as far as we can go on debating this issue. From a firm perspective, we are satisfied that we can give an opinion that 95(6) should not apply to deem the founder or Eligible Persons to own the shares of the OC, as long as they do not have any legal rights vis a vis the company or the shareholders. 1 KPMG LLP ln!'l Te:: ________ .. · - · - - - To Offshore Company File GST Spsr-;:l!"'"~ ~·----~------­ Date January 18, 200 I Rs'.'i~\'Wi (it :.~~;,.~-...:c..;r~) Tax P1rtnGr From Approval:--------- CCto: _ _ _ _ _ _ __ cc Barrie Philp Subject Offshore Company- Application of Subsection 95(6) I've reviewed the memorandum which you prepared concerning the application of subsection 95(6) dated January 2, 2001 and I am in substantial agreement with that memorandum. I would, however, like to make the following additional comments: 1. In my view, a person who has beneficial ownership in shares does not have a right, under a contract, in equity or otherwise either immediately or in the future-- to-shares of a capital stock. In my view, a person doesn't have a right to shares since the person already owns the shares. Any possible interpretation that a person who has a right to shares includes a person who owns shares would make subsection 95(6) redundant, and the other provisions of the Act which contains similar wording- for example, subsection 25!(5)(b). 2. Subsection 95(6)(a)(ii) states, in part, that where the principle purpose of the existence of the right is to permit any person to avoid or reduce or defer the payment of tax -those shares or partnership interests, as the case may be, are deemed to be owned by that person or partnership - - . In my view, the reference to that person or partnership must refer to the person or partnership referred to in 95(6)(a). That interpretation would be consistent with the other provisions of the Act which contains similar wording, ie. subsection 251(5)(b) and, in my view, 95(6) has similar meaning. In other words, the purpose of this provision is to provide for a person or partnership which does not own shares but who has some right to shares to be considered to actually own the shares. If the shares were then owned by that person or partnership, the ensuing tax consequences will result. In my view, it is not possible to interpret "that person or partnership" in subsection 95(6)(a)(ii) as referring to "any person" referred to in the same subparagraph. If the drafters wish to refer to "any person", they would need to have used different language in 95(6)(a)(ii) with reference to the person who is deemed to own the shares and would DODD ltPMG uP. a Ca,..dian owned limiled litbility pa"n~rship esubhshed under the J•ws of Ontario. is a member firm of KPMG lntern•tional. 1 Swiss anotiltion. rrt Page 2 have specifically needed to reference to "the person who is avoiding or reducing or deferring the payment of tax". The reference to that person or partnership must refer to the person or partnership referred to in 95(6)(a). Very truly yours, KPMG LLP PRIVATE & CONFIDENTIAL To Date January 17, 2001 Barrie Philp KPMG Vancouver From cc Subject George Denier, Paul Hickey Offshore Company- Application of ss. 95(6) While I believe your technical memorandum dated January 2, 2001 has a number of interesting and somewhat persuasive arguments, I am still concerned for a number of reasons set out below: I. If, as you argued, ss.95(6) should not apply, full ownership of shares by an accommodating party would result in potentially less adverse consequences than diminished rights of ownership, i.e) options rather than full ownership rights. 2. rL 'd:i- ,_·r,,.;.. ,,. TL •..d: rC.. . -« '"'.........x··. ( ··,."-"~iL£.~ l' ,,._._ .;n.. . - d _, 1 p.t..r'i ' ) '. If full ownership does not encompass a right to shares, then three (3) property regimes exist. 1. rights to acquire shares subject to ss.95(6); ii. rights to shares subject to ss.95(6); and 111. full ownership not subject to ss.95(6) I am uncertain as to why (iii) would not be included by inference within (ii) from a legal perspective. 3. I understand that there is lack of precision in the legal nature of a share. Brian Arnold and David Ward generally agree with the analysis of a share as a "bundle of rights". In their article in the Canadian Tax Journal, 1998 Vol. 28 No.5 CTJ 559-84, they state: DODD KPMG LLI', 1 C•n•di•n owned limit11d liabi~tr ptnnert.hip Ullblialled unde• the laws of Omario. is f membtr firm of KPMG lnternlliOnll, II Swi$$ IIIOCillion. '.j. .-~,<..:.>. 0 (.~ ~ll't...L. Page 2 "The precise legal nature of a share has never been clear, however. In Bradbury v. English Sewing Cotton Company Limited, an often quoted judgment as to the meaning of a share, it was stated: A share is, therefore, a fractional part of the capital. It confers upon a holder a certain right to a proportionate part of the assets of the corporation, whether by way of dividend or of distribution of assets in winding up. It forms, however, a separate right of property. The capital is the property of the corporation. The share, although it is a fraction of the capital, is the property of the corporator ... the share is a property in a fractional part of the capital. In another often quoted case, Borland's Trustee v. Steel, a share was defined as: ...... the interest of a shareholder in a company measured by a sum of money, for the purpose of liability in the first place, and of interest in the second place, but also consisting of a series of mutual covenants entered into by all the shareholders inter se ...... A share is not a sum of money .... but is an interest measured by a sum of money and made up of various rights contained in the contract, including the right to a sum of money of a more or less amount." On the basis of the foregoing, is there not a concern that full ownership does in fact provide the owner with rights to a whole bundle of rights which could be direct or derivative, etc. Ownership consists of innumerable rights over property, for example, the rights of exclusive enjoyment, of destruction, alteration and alienation, and of maintaining and recovering possession of the property from all other persons. Such rights are conceived not as separately existing, but as merged in one general right of ownership .. Even if we accept that a right to shares means something less than full share ownership, surely full ownership encompasses and includes rights to shares. On this basis, as well as \ ;'--;;' Page 3 for the reasons outlined in points I. and 2., ss.95(6) could still be considered to be applicable. 4. A number of the arguments were based on an "ordinary meaning" or strict interpretation approach. However, since ss.95(6) is an anti-avoidance provision, it may be open to the Courts to apply the "purposive" approach to statutory interpretation. ,.~l ?t~·C - (J...c( ·.,A •~, ' t 4: •)/ 5. I believe the purpose test in ss95(6)(a)(i) can still apply even where the eligible person ;?.... P""-1"; "'-.. .t...·- -~~- '-' ~.... .:. ._r_,_...:J. seeking to avoid or defer tax has no right to income or capital of the company and may never receive anything from the company. The reference to "any person" in ss.95(6)(a)(ii) is not necessarily restricted to the individual who divested himself of his assets. It could also apply, for example, where the purpose is to avoid tax payable by a family member who has been gifted the asset by another family member. In conclusion, I believe the issues are of a legal nature and, consequently, a legal view (as opposed to my accounting view) should be sought to support your position. Regards, . j, ....--;f - 11../'