The Canada Revenue Agency ("CRA") has released a preview of its new T1134 Summary and Supplement forms. If anyone needs proof that international tax is a complicated subject, a quick glance at these new forms will clearly settle the matter. As a reminder, T1134 filings are mandatory annual filings for Canadians who have an interest in a foreign affiliate (which is generally a foreign corporation in which a Canadian, together with related persons, own 10% or more). For taxation years that begin in 2021, the T1134 forms are due 10 months after the end of the taxation year. The new T1134 forms require a great deal more disclosure compared to the previous version. Completing them properly requires the preparer to have a decent understanding of, sometimes obscure, Canadian international tax rules.
There are some relieving changes coming out of this overhaul. The dormant / inactive administrative exception is expanded so that the $100,000 aggregate cost amount limit applies at a foreign affiliate by foreign affiliate level, and the annual gross receipt threshold is increased from $25,000 to $100,000. However, dormant / inactive foreign affiliates will need to be identified with certain base level information in the new T1134 Summary. Also, a new related group reporting regime is introduced so that a group of Canadian reporting entities may file only one set of consolidated T1134 forms.
The new T1134 forms require much more extensive disclosure than previously. Below are some of the new information being asked for:
- Whether the Canadian reporting entities are themselves involved in reorganization transactions under section 85, 85.1, 86.1, 87 and 88 of the Income Tax Act (the "Act").
- Adjusted cost base ("ACB") – rather than book cost- of common shares and preferred shares in the foreign affiliate.
- Unconsolidated financial statements are now required for a foreign affiliate where the reporting entity or a controlled foreign affiliate owns 20% or more voting shares in the foreign affiliate.
- Extensive questionnaire regarding the applicability of the foreign affiliate dumping rules to any investments made in respect of the foreign affiliate.
- Extensive questionnaire regarding the foreign affiliate surplus accounts.
- Extensive questionnaire regarding the upstream loan rules. An upstream loan from a foreign affiliate may have to be included in income if the loan is not repaid within two years (analogous to the subsection 15(2) rules in the domestic context) – taxpayer now must positively identify to the CRA whether these rules apply to their foreign affiliates.
- Extensive questionnaire regarding foreign affiliate dissolution: subsections 88(3), (3.1), (3.3) and (3.5).
- Disclosures regarding "equity percentage", "surplus entitlement percentage" and "participating percentage".
- Disclosure of number of employees – not just whether the foreign affiliate had more than 5 full-time employees.
- Traditional passive-type of revenues now have to be disclosed separately between those earned from an arm's length source versus those earned from a non-arm's length source.
- Detailed disclosure about foreign accrual property loss (FAPL) and foreign accrual capital losses (FACL). It is no longer good enough to provide a net foreign accrual property income (FAPI) amount.
- Disclosure of information required on lower-tiered foreign affiliates held by non-controlled foreign affiliates of the reporting entity.
The new information required is extensive and very intimidating to anyone other than a full-time international tax specialist. Combine this with a new 10-month filing due date, which has been shortened from 15 months prior to 2020, and it will likely be a rough transition for many accountants when the new T1134 forms are due in year 2022.
We definitely understand why the CRA would like a lot more disclosure and transparency for foreign affiliates. All the new information being asked for will help the CRA build a powerful database that they can use to better target their audit resources, and it is consistent with their emphasis on risk-based auditing. However, we believe this new T1134 is very ill-suited for most private enterprises who are just starting to expand outside Canada or most Canadian individuals looking to make modest investments in foreign entities.
In our experience as advisors to Canadian entrepreneurs and high net worth families, most investments in foreign affiliates are either (i) real estate investments or (ii) organic expansion of their Canadian businesses, and almost all of them are made in the U.S. and in other jurisdictions with highly developed tax regimes. One thing that these structures all have in common is that there are little to no Canadian income tax arising from them, because the foreign tax regime (again, typically the U.S.) already impose income tax on any foreign earnings at equal-to-or-higher-than rates that would have been charged in Canada. In tax technical speak: there is almost always either enough foreign accrual tax to shelter any FAPI income, or the foreign dividends would have been fully sheltered by the surplus regimes. For private enterprises investing in these developed countries, there are no tax 'games' being played and sometimes that is simply because the type of cross border tax mischief that newspaper headlines talk about are simply not economically feasible to implement for most Canadian private entrepreneurs and families.
Of course, there are exceptions where Canadian tax can arise in common cross-border structures. The most common we have seen is where a Canadian investor took advantage of the deferral rules under U.S. Code section 1031 ("like-kind" exchanges) to defer tax on a sale of U.S. property, not realizing that the Canadian FAPI rules would then apply due to no U.S. tax being imposed. These are, however, exceptions to the norm.
The new T1134 Forms are much more suitable for large multi-national enterprises than for private enterprises and individuals. We firmly believe that the CRA should have created a simplified T1134 disclosure form for Canadian individuals and private corporations investing in a "safe" list of high tax rate countries such as the U.S. The CRA may even limit the simplified form to a certain dollar threshold of annual activities. A similar approach has been taken with the Form T1135 where reporting is very streamlined when specified foreign property totals less than $250,000. Why can't a similar approach be taken for T1134?
It is no secret that Canadian businesses and individuals need to look outside Canada for opportunities, especially for many businesses in beaten-down Alberta. A complex annual filing requirement like the new T1134 is a sure way to discourage them. Many of these businesses and individuals cannot afford international tax specialists to help them with completing the new T1134, while at the same time, the form emphasizes that penalties will be applied if the forms submitted to the CRA are not correct and complete. These penalties can go up to the greater of $24,000 or 5% of the investment per form, per year. What is a small business looking to expand into the U.S. or an investor looking to purchase U.S. property through a U.S. corporation to supplement his or her retirement income to do?
There is still time for the CRA to design a simplified T1134 form for the average Canadian investing in foreign entities, before T1134s are due for the 2021 year. However, we have learned not to be optimistic when hoping for taxation and simplification. Therefore, advisors need to learn what are in these forms, start getting prepared to gather the necessary information, and advise their clients of this upcoming change to their annual compliance.
Moodys Tax Law is only about tax. It is not an add-on service, it is our singular focus. Our Canadian and US lawyers and Chartered Accountants work together to develop effective tax strategies that get results, for individuals and corporate clients with interests in Canada, the US or both. Our strengths lie in Canadian and US cross-border tax advisory services, estateplanning, and tax litigation/dispute resolution. We identify areas of risk and opportunity, and create plans that yield the right balance of protection, optimization and compliance for each of our clients' special circumstances.
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