Canadian banks were affected by many significant Canadian tax developments in 2016.
As a helpful reminder, KPMG has prepared the following summary of these developments that you can review to ensure you have properly considered their implications for your business.
The 2016 changes affecting the banking industry include:
Common Reporting Standard - Start collecting non-resident account details
In 2016, Canada introduced legislation to implement the Common Reporting Standard (CRS), based on a standard developed by the OECD to move towards a globally coordinated approach to automatically exchange tax information between jurisdictions. Canadian banks will soon have to collect information on the financial accounts that are held by tax residents of jurisdictions other than Canada and the United States, and provide these details to the CRA. Banks must have procedures in place by July 1, 2017 to identify accounts to be reported and to collect the requisite information.
This information will be sent to the CRA starting in 2018 and will be shared with other countries' tax authorities in exchange for reciprocal information about accounts held in those other jurisdictions by Canadians.
Canada's CRS rules include concepts that are largely drawn from the U.S.-based Foreign Account Tax Compliance Act (FATCA), which has a similar focus on financial accounts and the financial institutions that maintain them. As a result, Canadian banks may be able to leverage certain aspects of the systems they currently have in place to meet the Canadian rules that require them to comply with FATCA. However, there are important distinctions between FATCA and CRS and, as a result, governance related to each regime should be maintained separately.
Areas for Canadian banks to address in implementing CRS include:
For full details on these implementation areas, see TaxNewsFlash-Canada 2016-22, "FIs - Get Ready for New Common Reporting Standard Rules" and TaxNewsFlash-Canada 2016-40, "Canadian FIs - Start Collecting Non-Resident Account Details".
Country-by-country reporting - First reports for 2017 years due in 2018
In 2016, Canada passed legislation implementing Country-by-Country (CbyC) reporting requirements that apply to Canadian multinational enterprises, including banks, with consolidated group revenues that are equal to or exceed â‚¬750 million. The first Canadian CbyC reporting due date, for a Canadian bank with an October 31 year-end, is October 31, 2018 for the fiscal year ending October 31, 2017. Canadian banks should also consider other jurisdictions in which they may have CbyC reporting requirements that are not precluded by compliance with Canadian's CbyC reporting legislation.
Canada's CbyC reporting legislation does not provide details on the contents of the country-by-country report. The legislative proposals only state that the report must be in the prescribed form and filed in the prescribed manner. However, based on Finance's comments, it is likely that the Canadian CbyC report will be very similar to the OECD's recommendations in BEPS Action 13: Transfer Pricing Documentation and Country-by-Country Reporting. The OECD recommends that the CbyC report should include the global allocation of the following information on a country-by-country basis:
The mechanism for filing the Canadian CbyC report is unclear. We expect that the CRA will release further administrative guidance during 2017 that should provide clarification on the required information and filing procedures.
New guidance for inter-corporate dividend anti-surplus stripping rule
In the 2016 budget, the CRA introduced changes to the anti-surplus stripping rule in subsection 55(2) of Canada's Income Tax Act that have broad implications for corporations expecting to pay or receive inter-corporate dividends. The rule, which can cause a tax-deductible inter-corporate dividend to be recharacterized as a capital gain, was significantly expanded for inter-corporate dividends received after April 20, 2015. The new rules introduce new "purpose" tests that create some uncertainty in the way taxpayers could expect these amended rules to apply.
Although the purpose tests, together with other changes to the rules, significantly expand subsection 55(2), the safe income exception still applies where the company has sufficient safe income from which to distribute the dividend. In 2016 the CRA continued to encourage taxpayers to calculate safe income on hand to determine if the safe income exception is available, since the expanded rule can apply in more situations than before-including situations where dividends are paid between related corporations.
The CRA provided additional guidance in 2016, covering issues related to the purpose tests and the exceptions to the application of subsection 55(2). Related to the safe income exception, Canadian banks may have to consider the CRA's comments on the allocation of safe income to discretionary dividend shares under the new rules. Specifically, the CRA introduced the concept of using a "global approach" to the allocation of safe income where all of the corporation's shares are participating, discretionary dividend shares. Under the global approach safe income can be streamed to one class of shares to the exclusion of others in certain situations. Where there are discretionary dividend shares that are non-participating, the CRA says that the allocation of safe income will depend on whether the shares have value in excess of their adjusted cost base, which can only be determined based on the particular facts.
The CRA, however, said that the global approach does not apply on the allocation of safe income between two classes of participating, discretionary dividend shares where one class is being disposed of through a redemption or dividend followed by a purchase for cancellation. The CRA said that the global approach did not apply because the fair market value of the remaining class of shares remained unchanged following the redemption or dividend.
The CRA also commented on the allocation of safe income between different classes of participating, discretionary dividend shares where the corporate shareholders have different holding periods and the dividend recipient acquired its shares after the other shareholders. The CRA clarified that the full amount of the safe income earned after the dividend recipient acquired its shares could be allocated to that shareholder if the hypothetical capital gain on those shares was more than that amount.
At the 2016 Canadian Tax Foundation annual conference, the CRA said it will be studying the discretionary dividend shares further and will not provide additional views on the use of these shares until the study is complete.
The CRA's global approach leaves some uncertainties. For example, it is still not clear how to allocate safe income to particular shareholders where dividends are paid to multiple shareholders having different holding periods under the global approach. The CRA's study on discretionary dividend shares will likely address the possibility that the global approach could result in undue tax advantages.
New FX methodology for convertible securities
In Agnico-Eagle Mines Ltd. (Agnico) v. The Queen, the Federal Court of Appeal (FCA) set out a methodology for determining foreign exchange (FX) gains and losses on the conversion of U.S.-dollar denominated convertible debentures into shares. This decision reverses a prior Tax Court of Canada (TCC) decision.
A gain or loss in a taxation year that arises from a value fluctuation in the currency of a country other than Canada is deemed to be a capital gain or loss for the year. In its decision, the FCA disagreed with the TCC's earlier finding that FX gains were only realized on the redemption of certain debentures for cash. The FCA held that a taxpayer would have an FX gain on the conversion of a debenture if, in Canadian dollars, the amount of the issue price of the convertible debenture exceeded the repayment amount when the indebtedness was extinguished to the debenture holders. To determine these amounts, the FCA said it is appropriate to use the FX rate on the issue date of the debenture and the FX rate on the date of conversion, respectively. Further, the FCA held that the amount paid to extinguish the debt on a debenture on conversion was the applicable securities exchange trading price of the common share on the conversion day.
The CRA later clarified that the FCA's methodology could result in an issuer of debentures realizing a loss. At the CRA Roundtable in the Canadian Tax Foundation's 2016 Annual Conference, the CRA said that, in its view, there is no loss on the conversion under subsection 39(2) because the loss was not a loss from the fluctuation of currency relative to the Canadian dollar. Further, in the CRA's view, the loss does not arise under subsection 39(1) either because it arose on the settlement of debt (due to the appreciation of the value of the shares). Therefore the loss could not be applied against capital gains.
The CRA said that, although not argued in the Agnico-Eagle case, it would consider applying subsection 143.3(3) to similar facts which would change the calculation of the gain or loss. The CRA would consider whether, on a conversion, the holder is exercising an option such that the amount paid by the holder is the cash value of the debenture for purposes of paragraph 143.3(3)(b).
For details, see KPMG's TaxNewsFlash-Canada 2016-52, "Asset Managers - New FX Methodology for Convertible Securities".
Derivatives - Mark-to-market accounting method valid
In Kruger Incorporated v. The Queen, a recent case regarding the valuation of derivative contracts for tax purposes, the FCA determined that a non-financial institution (Canco) could apply the mark-to-market accounting method to its FX options for tax purposes. The FCA stated that the realization principle is not an "overarching principle". Therefore, as Canco had established that the mark-to-market accounting method provided an accurate picture of Canco's income for the year and as the CRA had not shown that the realization principle provided a better picture of Canco's income, Canco could use the mark-to-market accounting method for purposes of determining income under section 9 of the Act.
Banks are subject to current tax on their accrued gains and losses on mark-to-market property during the taxation year. Mark-to-market property is broadly defined for tax purposes to include certain shares of a corporation, certain "specified debt obligations" and "tracking properties". A property is a "tracking property" if its fair market value is determined primarily by reference to one or more of certain criteria (e.g., fair market value, revenue) in respect of a mark-to-market property. The CRA has taken the administrative position that FX options are mark-to-market property even though these options are not included in the mark-to-market property definition in the Act. This allows banks and other financial institutions to value FX options as mark-to-market property.
This FCA decision provides further support that Canadian banks are entitled to apply mark-to-market principles to compute taxable income relating to FX options and derivatives, including written options that are considered liabilities, where this provides a more accurate picture of income.
Sale of linked notes - New rules treat gain as interest
As of January 1, 2017, the return on a linked note retains the same character whether it is earned at maturity or through a secondary market sale. In particular, a deeming rule will apply in certain cases to treat any gain realized on the sale of a linked note as interest that accrued on the debt obligation for a period commencing before the time of the sale and ending at that time.
When a linked note is denominated in a foreign currency, foreign currency fluctuations are ignored for the purposes of calculating this gain. The character of the foreign currency gain will therefore be established using general principles that apply to the taxation of foreign exchange gains and losses and, depending on the investor's particular facts and circumstances, the foreign currency gain or loss may be treated on capital account.
An exception is provided to the deeming rule where a portion of the return on a linked note is based on a fixed rate of interest. In this case, any portion of the gain that is reasonably attributable to market interest rate fluctuations will be excluded.
For more information, contact your KPMG adviser.
Information is current to January 31, 2017. The information contained in this publication is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act upon such information without appropriate professional advice after a thorough examination of the particular situation. For more information, contact KPMG's National Tax Centre at 416.777.8500