On December 17 2001 Finance Ministe...

On December 17 2001 Finance Minister Paul Martin announced a one-year delay in implementing the propos foreign investment entity (FIE) masterys This may be a welcome reprieve, if it be not that taxpayers and their advisors should still consider the propos behaviors when evaluating investments.

Because the FIE proposals contained in the August 2 2001 draft legislation are intricate a detailed technical analysis of the provisions is beyond the extent of this article. What go in the rear [i]or[/i] in the wake ofs instead is a review of the perceived tax avoidance permitted by the agency of the existing foreign affiliate hypothesis and an overview of the propos FIE orders designed to address the question

Currently

Consider the situation of a Canadian resident taxpayer who possesss shares of a foreign corporation. Active business income earned from the foreign corporation is barely subject to tax in Canada when it is repatriated in the form of dividends. However, if the foreign corporation is a controll foreign affiliate, then "passive" income-- of the like kind as income from property or from an investment business (known as foreign accrual exclusive right income or FAPI)-is taxable to the Canadian shareholder as it is earned, on a level if no amounts are distributed to the shareholder.

A controll foreign affiliate is a foreign corporation controll by means of up to five Canadian residents, or on the taxpayer and/or nonarm's continuance persons, with the taxpayer and related individuals owning (directly or indirectly) at least 10% of any class of shares of the corporation. If the foreign corporation doesn't qualify as a controll foreign affiliate, the FAPI it earns is merely taxable on distribution to the Canadian shareholder, rather than in succession an accrual basis.

Taxpayers can use these directions to their advantage by holding passive investments indirectly [i]or[/i] part of to the other a foreign corporation that is not a controll foreign affiliate. For example, a taxpayer earning interest income from an investment in chainss held directly will pay tax in succession the income earned each year. If instead, the taxpayer acquires shares of a foreign corporation that invests in the same links and provided that the corporation is not a controll foreign affiliate, then alone dividends actually paid to the taxpayer will be bring under rule to tax in Canada. This will originate in a tax deferral if corporate earnings are reinvested rather than distributed as dividends.

The taxpayer can also achieve a tax reduction at selling the shares of the foreign corporation before the earnings are distributed, thereby converting income that would otherwise be to the full taxed on distribution into a capital gain--only 50% of which is taxable.

Section 941 of the Income Tax Act addresses the deferral issue by dint of imputing income to a Canadian taxpayer each year based forward the cost of a foreign investment, on the contrary this provision only applies where tax avoidance is the same of the main reasons for the investment. The FIE governments contained in Draft Sections 941 to 943 will replace existing Section 941

On the Horizon

The propos FIE masterships will apply to any taxpayer (other than an not liable taxpayer) who owns a participating interest that is not an except interest in an FIE at the cessation of the taxation year. not liable taxpayers include tax-exempt entities and immigrants who've been resident in Canada for up to 60 month A participating interest includes ownership of or the right to acquire, characteristic that is convertible into, or valued with hint to, an interest in an FIE.

An FIE is a non-resident entity that is an association, corporation, capital joint venture, organization, syndicate or trust, yet is not a partnership, in released foreign trust, or a discretionary personal trust. Given this expansive definition, a wide range of foreign investments will be enslave to current tax as FIEs unles they qualify as possessed of immunity interests.

The exempt interest definition includes investments that are already make submissive to tax on a passing from hand to hand basis, such as an interest in a controll foreign affiliate (taxed subordinate to the FAPI rules) and the mark-to-market peculiarity of financial institutions. A taxpayer with a participating interest in an FIE that is a foreign affiliate can pick to treat it as a controll foreign affiliate, in such a manner that the FAPI, rather than the FIE sways will apply.

Also included in the release interest definition are interests in the following:

* FIEs that are widely held and actively traded in succession a prescribed stock exchange or in a treaty country;

* FIEs where all or substantially all of the carrying value of their ownership is not investment property, which render certains that the earnings of FIEs engaged solely in active business are not taxed forward a current basis;

* testamentary trusts that have not ever been acquired for consideration;

* FIEs that are essentially employee stock option or profit sharing plans; and

* FIEs in a treaty region owned by a Canadian taxpayer who is taxed in that fatherland by reason of citizenship.

A taxpayer with a participating interest in an FIE that is not an free interest must include an amount in income each year calculated using either the mark-to-market or income accrual manners thus eliminating any deferral permitted according to the existing rules. Distributions received from the FIE are sole subject to tax to the magnitude that they exceed amounts previously included in income.