CHAPTER 09 Selected Canadian Tax Issues in M&A Transactions
– Interest paid to non-arm’s-length non-residents is subject to Canadian withholding tax at the rate of 25%, subject to a reduction when a Canadian tax treaty applies. Interest paid to non-arm’s- length persons entitled to the benefits of the Canada–U.S. tax treaty is not subject to withholding tax, provided the interest is not contingent interest (as defined in the Canada–U.S. tax treaty). – Dividends paid to non-residents are subject to withholding tax at the rate of 25% unless a Canadian tax treaty applies. Typically, tax treaties reduce the rate to 15%, or to 5% for shareholders that are corporations owning at least 10% of the dividend payer’s voting shares. – Thin capitalization rules deny the deduction of interest paid by Canadian corporations to specified non-residents to the extent that it relates to debt owing to specified non-residents that exceeds 1.5 times the corporation’s relevant equity. Similar rules apply to partnerships, trusts and non-resident entities carrying on business in Canada. > Under these rules, up to 60% of the capitalization can take the form of shareholder debt, generating tax deductions in Canada. ○ Essentially, a “specified non-resident” is (i) a non-resident that holds 25% or more of borrower’s shares (by votes or value), either alone or with non-arm’s-length persons and taking into account rights in respect of shares; or (ii) a non-resident that does not deal at arm’s length with a shareholder with such a shareholding. ○ In general, only debt that is owed to specified non-residents is taken into account, so arm’s-length deal financing typically does not affect thin capitalization limits. ○ An anti-avoidance rule may apply to “back-to-back” loans when a specified non-resident provides credit support to a third party that lends funds to the Canadian corporation. These rules are intended to prevent the use of accommodation party financing to skirt the thin capitalization rules, but the rules also limit the ability of corporate groups to funnel financing through entities located in jurisdictions with favourable tax treaty rates. ○ Relevant equity is computed as the total of (i) paid-up capital and contributed surplus that is attributable to specified non-resident shareholders, and (ii) retained earnings. ○ Interest that is not deductible because of the thin capitalization rules is treated as a dividend for withholding tax purposes. ○ The payment of dividends or returns of capital by the Canadian corporation will reduce its relevant equity for thin capitalization purposes (although the payment of a dividend that increases a deficit of retained earnings has no effect). Accordingly, careful planning is required. – In addition to the thin capitalization rules, Canada has enacted Excessive Interest and Financing Expenses Limitation (EIFEL) rules which generally limit the deductibility of net interest and financing expenses of corporations and trusts to 30% of EBITDA. – Canada has enacted certain exceptions and has proposed additional exceptions to the EIFEL rules to support certain taxpayers. Public-private partnerships, purpose built rental housing, regulated energy utilities and small Canadian-controlled private corporations may be exempt
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