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Canadian taxation of business and investment income of non-residents 1972

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CANADIAN TAXATION OF BUSINESS AND INVESTMENT INCOME OF NON - RESIDENTS by ROCCO BONZANIGO L i c e n c i e en D r o i t de l ' U n i v e r s i t e de Geneve, 1969 Avocat au Barreau de Geneve, Switzerland, 1971 a thesis submitted i n p a r t i a l f u l f i l m e n t of the requirements f o r the degree of MASTER OF LAWS i n the Department of LAW We accept t h i s thesis as conforming to the required standard The U n i v e r s i t y of B r i t i s h Columbia May, 1972 In presenting t h i s thesis i n p a r t i a l fulfilment of the requirements for an advanced degree at the University of B r i t i s h Columbia, I agree that the Library s h a l l make i t freely available for reference and study. I further agree that permission for extensive copying of t h i s thesis for scholarly purposes may be granted by the Head of my Department or by his representatives. I t i s understood that copying or publication of t h i s thesis for f i n a n c i a l gain s h a l l not be allowed without my written permission. Department of LAW The University of B r i t i s h Columbia Vancouver 8, Canada Date May. 1972 ( i ) ABSTRACT Canadian Taxation of Business and Investment Income of Non-Residents The new Income Tax Act (S.C. 1970-71, c.63), formely known as B i l l C-259, has introduced important changes and many new rules into Canadian l e g i s l a t i o n , which a f f e c t taxation of non-residents. This t h e s i s i s a study of the tax treatment which the new law imposes on non-residents and an examination of the di f f e r e n c e s from the previous system. However, taxation of non-residents depends not only on statutes but a l s o on case law. Therefore, a t t e n t i o n i s devoted to j u d i c i a l decisions to a s c e r t a i n whether they c o n f l i c t with the new statutory p r o v i s i o n s . This thesis studies non-residents earning income from a business they carry on i n Canada, and d e r i v i n g income from investments they make i n Canada. The comparatively simple s i t u a t i o n s of persons holding employments i n Canada, or r e c e i v i n g pension payments from Canadian sources are not analyzed. The study i s l i m i t e d to the law normally a p p l i c a b l e without modifications dependent on i n t e r n a t i o n a l t r e a t i e s . The thesis i s organized i n seven main chapters and a short conclusion. The f i r s t chapter summarizes the reasons making taxation of non-residents a complexe matter, and the rules governing i t . The second chapter i s devoted to the d e f i n i t i o n of residence as well as to a b r i e f comparison with c e r t a i n other countries. The tax consequences of non-residents ( i i ) c a r r y i n g on business i n Canada and the methods a v a i l a b l e are examined i n the t h i r d chapter. The taxation of the d i f f e r e n t forms of investment income which non-residents may derive from Canada i s the object of the fourth chapter. The non-resident-owned investment corporation, that i s to say the s p e c i a l v e h i c l e afforded to foreign i n v e s t o r s , i s analyzed i n the f i f t h chapter. The s i x t h chapter explains the t e c h n i c a l provisions aimed at counteracting t h i n c a p i t a l i z a t i o n . The taxation of c a p i t a l gains r e a l i z e d by non-residents i s studied i n the chapter seven. F i n a l l y , some conclusions are drawn i n the eighth and l a s t chapter. ( i i i ) T A B L E O F C O N T E N T S Page I. A SUMMARY OF CANADIAN TAXATION OF NON-RESIDENTS 1 I I . RESIDENCE IN CANADA 9 1. Indiv i d u a l s 10 A. Common Law 10 B. Statute 14 ( i ) In general 14 ( i i ) S p l i t - r e s i d e n c e 16 2. Corporations 18 A. Common Law 18 B. Statute 22 3. Conceptual Comparison with C e r t a i n Other Countries 24 I I I . ACTIVE BUSINESS INCOME EARNED IN CANADA BY NON-RESIDENTS 29 1. Carrying on Business i n Canada 29 A. Business' 29 B. Carrying on Business i n Canada 30 C. Carrying on Business through an Agent 34 D. Carrying on Business by Owning Real Estate 38 E. Income from Carrying on Business 40 F. Ship and A i r c r a f t Operations 43 2. Comparison of Methods 44 A. Individuals 44 B. Companies 49 ( i ) Branch 49 ( i i ) Subsidiary 52 3. A d d i t i o n a l Branch Tax 56 (iv) Page IV. INVESTMENT INCOME EARNED FROM CANADA BY NON-RESIDENTS 61 1. In General 61 2. Interest 65 3. Dividends 71 4. Rent 76 5. Royalties 81 A. In General 81 B. Know-how Payments 82 C. Motion P i c t u r e Films 87 6. Management Fees 88 7. Trust and Estate Income 92 V. NON-RESIDENT-OWNED INVESTMENT CORPORATION 97 A. D e f i n i t i o n 98 B. Computation of Income and Tax 100 C. Dividend D i s t r i b u t i o n 103 D. Refund of Tax 106 E. C a p i t a l Gains on Sale of NRO Shares 108 VI. THIN CAPITALIZATION 110 A. In General 110 B. Loans to Company 112 C. Disallowance f o r Interest Payment Deduction 113 VII. CAPITAL GAINS 117 1. In General 117 2. Non-Residents 120 A. Taxable Canadian Property 121 B. Enforcement of Tax 123 3. Emigrants 126 A. Deemed D i s p o s i t i o n 127 B. Def e r r a l E l e c t i o n 129 4. Immigrants 131 VII I . CONCLUSION 132 FOOT - NOTES 138 BIBLIOGRAPHY 148 TABLE OF CASES 152 1 I. A SUMMARY OF CANADIAN TAXATION OF NON-RESIDENTS One of the fundamental rules of the f e d e r a l INCOME TAX ACT i s the d i v i s i o n of taxpayers i n t o two categories: residents and non-residents. These two classes are subject to d i f f e r e n t treatment depending upon t h e i r d i f f e r e n t s i t u a t i o n s . The p r i n c i p l e i s that resident taxpayers pay an income tax on t h e i r world income — s.2(l) and s.3 I.T.A.— whereas, generally speaking, non-residents are l i a b l e to pay taxes on the income earned i n — s . 2 ( 3 ) I.T.A.— and derived from Canada — Part XIII I.T.A. — . The general j u s t i f i c a t i o n f o r taxing non-residents earning income in s i d e a country seems to be that they f i n d themselves i n a p o s i t i o n s i m i l a r to that of r e s i d e n t s . As they b e n e f i t , even i f to a smaller extent than people r e s i d i n g i n that country, from the general p u b l i c expenditures, they have to contribute to the country's maintenance by re m i t t i n g an income tax on the revenue they obtain from employment or business i n that country, j u s t as other r e s i d e n t s . I t i s more d i f f i c u l t to f i n d an explanation f o r the taxes l e v i e d on the income that non-residents receive from a country. The reason i s probably that (except p a r t i c u l a r cases) countries do not want to be tax-havens nor do they want to miss the opportunity to c o l l e c t wherever they can the monies they need. 2 In every country the taxation of non-residents i s a d e l i c a t e matter because of r e l a t e d i n t e r n a t i o n a l problems, because of the necessity to reach a f a i r balance between resi d e n t s ' and non-residents' tax burden and because such taxation may be considered and used as an instrument of economic p o l i c y . A too generous treatment of non-residents would a t t r a c t l a r ge investments from f o r e i g n sources. That could have undesi- rable consequences: first,much of the economic a c t i v i t y would be c o n t r o l l e d by people r e s i d i n g i n other countries; second, the p r o f i t of such businesses and investments would not remain i n the country but would flow to the f o r e i g n investors; f i n a l l y , the residents being assessed more severely would be discouraged from c a r r y i n g on businesses and making savings f o r investment purposes i n t h e i r own country. Conversely, too heavy a tax burden imposed upon non-residents could prevent them from i n v e s t i n g i n the country and might leave i t without the c a p i t a l necessary f o r the development of i t s economy. Although a state may also r e l a t e on other means to keep under c o n t r o l the growth of f o r e i g n investments i n order to avoid an excessive dependence upon decisions taken abroad, there i s no doubt that tax l e g i s l a t i o n i s one of the most e f f e c t i v e means and one of the most frequently used. The Canadian s i t u a t i o n i l l u s t r a t e s the complexity of the problem and of the d i f f i c u l t y i n reaching a s a t i s f a c t o r y compromise. With i t s extensive t e r r i t o r y and i t s great p o t e n t i a l of natural resources Canada may welcome, up to a c e r t a i n l e v e l , the inflow of fo r e i g n c a p i t a l which i t needs to set up the structures permitting the e x p l o i t a t i o n of resources and, con- sequently, making i n d u s t r i a l production p o s s i b l e . The f o r e i g n investors 3 are a t t r a c t e d to Canada because of both the high y i e l d s they can obtain and the p o l i t i c a l s t a b i l i t y of the country. The r e s u l t i s , however, that some sections of the Canadian economy are l a r g e l y i n fo r e i g n hands. When one says f o r e i g n hands one r e a l l y thinks of American hands, as there i s no secrecy about the overwhelming predominance of Americans among non- -resident investors and corporations i n Canada. The s i t u a t i o n may be better i l l u s t r a t e d with the support of some figures to be found i n the Watkins Report on Foreign Property of 19681 In 1964 foreigners owned $ 33 b i l l i o n ; of assets i n Canada. The f o r e i g n long-term investments amounted to $ 27 b i l l i o n , 60 % of which ($ 15.9 b i l l i o n ) was constituted by f o r e i g n d i r e c t investments : the U.S. part of these d i r e c t investments accounted f o r 80 %. As to p o r t f o l i o investments non-residents owned 19 % of a l l Canadian funded debt : 16 points of t h i s belonged to the U.S.. In 1963, foreigners c o n t r o l l e d 97 % of the c a p i t a l employed i n the automobiles and parts, 97 % i n rubber, 78 % i n chemicals and 77 % i n e l e c t r i c a l apparatus; the corresponding figures f o r U.S. c o n t r o l were 97 %, 90 %, 54 % and 66 %. Another author wrote i n 1969 that the United States accounted f o r over 80 % of fo r e i g n d i r e c t investment i n Canada and about 70 % of f o r e i g n p o r t f o l i o . In 1967 the U.S. investments i n Canada amounted to $ 29.4 b i l l i o n . Roughly estimating, about 45 % to 50 % of corporate equity i n Canada was owned by U.S. c i t i z e n s 1 ? Through i t s i n t e r n a t i o n a l provisions the new income tax l e g i s l a t i o n purports to preserve the i n t e g r i t y of the tax system and at the same time to accomo- 4 date i t to the foreign systems. This i s c r u c i a l because of the openness of the Canadian economy and the necessity f o r i t to a t t r a c t f o r e i g n inve- stments. The l e g i s l a t o r s sought to create a system which would treat f o - reign investors f a i r l y without allowing opportunities f o r abuse.^ The new f e d e r a l INCOME TAX ACT (S.C. 1970-71, c.63), formerly known as B i l l C-259, which came i n t o force on January 1,1972 increases the taxation of revenues earned by non-residents from investments made i n Canada (with- holding t a x ) . I t maintains the taxation of income earned i n Canada by non-residents and, l i k e the old system, applies to them the same method of computation as to res i d e n t s . Moreover, non-residents w i l l s u f f e r f o r the f i r s t time, together with Canadians, an income tax l e v i e d on c a p i t a l gains r e a l i z e d when disposing of Canadian property. But the new system as provided i n the Act w i l l not always apply as such, f o r Canadian i n t e r n a t i o n a l taxation l a r g e l y depends on b i l a t e r a l f i s c a l conventions which generally e s t a b l i s h f o r residents of one country (party to the convention) earning any revenues i n the other country a more favou- rable treatment than that provided i n the Act. At present Canada i s bound 2 by double taxation t r e a t i e s to some sixteen countries . The government has plans to renegotiate and to enlarge the t r e a t i e s ' framework by 1975. For t h i s reason some provisions i n the Act concerning non-residents are tempo- r a r i l y modified u n t i l 1976 by the 1971 Income Tax A p p l i c a t i o n Rules ( t r a n s i - t i o n a l p r o v isions) i n order to avoid some of the c o n f l i c t s with e x i s t i n g t r e a t i e s Very b r i e f l y summarized Canadian taxation of non-residents may be explained as f o l l o w s . 5 Every non-resident person pays tax upon h i s taxable income earned i n Canada. The new element, i n contrast with the old l e g i s l a t i o n , i s that the income need not to be earned i n the taxation year but may have been earned i n any previous year [s.2(3)1.T.A.]. This income may be obtained from employment or o f f i c e s performed i n Canada or from carrying on business i n Canada. The taxable income also includes one h a l f of the c a p i t a l gains r e a l i z e d on the d i s p o s i t i o n of taxable Canadian property, one h a l f of the c a p i t a l losses being deductible according to the provisions r e l a t i n g to t h i s matter. The general r u l e applies to both i n d i v i d u a l s and corporations, s.248 I.T.A. d e f i n i n g the expression "person" as i n c l u d i n g 'any body corporate and po- l i t i c " . The computation of income, the allowance of deductions and exem- ptions and the determination of taxable income are made i n the same way as f o r resident taxpayers except f o r a few p a r t i c u l a r adjustments; the rates of tax c a l c u l a t i o n are the same a l s o . I f the business i s c a r r i e d on by a non-Canadian corporation (the old Act read "non-resident" corporation), which i s surely the case with a non-resident corporation, an a d d i t i o n a l tax of 25%, reduced to 15% u n t i l the end of 1975, i s l e v i e d on the a f t e r - t a x p r o f i t s (Part XIV I.T.A.). Non-residents pay an income tax on the returns of t h e i r investments and property, returns paid or c r e d i t e d to them by debtors or payers r e s i d i n g i n Canada. This income tax as i n the provisions of Part XIII I.T.A. applies to i n t e r e s t , dividends, rent, income from t r u s t s or estates, r o y a l t i e s and s i m i l a r payments and management fees. I t may be noticed that the same tax 6 i s imposed on alimony payments and, since the new system has s t a r t e d , on pension plan benefits as w e l l as annuity and retirement savings plan payments. Such income tax i s a merely proportionate but not progressive one, being computed at a f l a t rate of 25%, reduced u n t i l 1976 to 15%, of the gross income (without any deduction) received by the non-residents. The rate applied on dividends may be lower than the normal one i f the paying company has a degree of Canadian ownership, a complicated notion r e l a t e d to the equity and the d i r e c t o r s h i p . This tax i s a withholding tax as the debtor generally has, i f he wants to avoid any personal l i a b i l i t y , to withhold the tax amount on what he pays to the non-resident c r e d i t o r . A s p e c i a l a l t e r n a t i v e i s offered i n the case of r e n t a l of r e a l property, i n order to allow the non-resident to determine hi s income from property as h i s p r o f i t therefrom. If the non-resident disposes of the asset, the possible y i e l d of which has been subject to withholding tax, he of course f a l l s under s.2(3)I.T.A. as having disposed of a taxable Canadian property. Non-resident persons have a wide choice as to the way of earning income i n or from Canada. Individuals may do i t themselves or through an agent and so be taxed l i k e r e sidents, the tax burden being more or l e s s heavy according to the bracket applying to t h e i r taxable revenue. They also can incorporate a company resident i n Canada, which pays income tax at the o r - dinary f i x e d corporate rate, and they then remit the withholding tax to be l e v i e d on the dividends d i s t r i b u t e d by the company. Foreign corporations may act themselves and be subject to the corporate tax upon t h e i r income; i f they run a business, the a d d i t i o n a l tax i s imposed on the a f t e r - t a x p r o f i t s . Otherwise, they are able to incorporate a s u b s i - 7 d i a r y which i s normally taxed as being resident i n Canada, and then to pay the withholding tax on dividends received from that s u b s i d i a r y . When non-residents want to make f i n a n c i a l investments alone i n Canada they have the opportunity.instead of i n v e s t i n g d i r e c t l y , of s e t t i n g up a non-resident-owned investment corporation , incorporated i n Canada, which deals with the investments i n i t s own name. The company's income tax i s then c a l c u l a t e d at a s p e c i a l low rate of 25 % r e s p e c t i v e l y 15 %. This i n s t i t u t i o n already existed under the old l e g i s l a t i o n , but i t i s now more d i f f i c u l t to q u a l i f y as such a corporation. There are s e v e r a l new concepts , owing to the f a c t that the dividends paid out are no longer exempt from the withholding tax and that the company may claim a refund on i t s tax payment. Generally speaking, however,the main purpose of c r e a t i n g a non-resident-owned investment corporation i s to have the investments' income as though i t flows d i r e c t l y to the non- resident shareholders. Non-residents may wish, rather than use t h i s p a r t i c u l a r form of corporation, to make t h e i r investments through the same investment corporations, mutual fund corporations and mutual fund t r u s t s , which are a v a i l a b l e to resident i n v e s t o r s . The non-resident shareholder of a resident corporation c a r r y i n g on business might favour lending money to t h i s company rather than subscribing f o r more shares. Such a s o l u t i o n i s penalized by the new B i l l , w h i c h does not allow an excessive t h i n c a p i t a l i z a t i o n of companies i n which a s u b s t a n t i a l part of the shares — at l e a s t 25 % — are owned 8 by non-residents. The p e n a l i z a t i o n consists i n p r o h i b i t i n g the corporate taxpayer from deducting a proportion of otherwise deductible i n t e r e s t when determining income. The i n t e r e s t paid to the non-resident share- holder, whether or not deductible, i s s t i l l l i a b l e for withholding tax. 9 I I . RESIDENCE IN CANADA As pointed out at the beginning of the f i r s t chapter, an e s s e n t i a l d i s t i n c t i o n between resident and non-resident taxpayers must be made. I t i s impossible of course to try to define the concept of non-resident; s.248 I.T.A. simply explains that non-resident means non resident i n Canada. Therefore the only way to determine whether a taxpayer i s a non-resident seems to be to examine the r u l e s and the c r i t e r i a governing the determination of "resident i n Canada'. It being established that one does not reside i n Canada i t follows that one i s a non-resident f or the purposes of the income tax l e g i s l a t i o n . In f a c t i n Canada the general taxation l i a b i l i t y , implying that a tax i s l e v i e d on the world income, i s based upon residence. Domicile and c i t i z e n s h i p are i r r e l e v a n t , whereas i n the U.S. American c i t i z e n s h i p i s a tax bas i s i n case of non-residence (s.911 I n t e r n a t i o n a l Revenue Code). The j u s t i f i c a t i o n of the choice of residence as a general basis f o r taxation i s the recogn i t i o n of the economic a l l e g i a n c e e x i s t i n g between a person and the country where he has his p r e v a i l i n g economic i n t e r e s t s . For Canada one of the reasons of choosing the residence has 3 probably been the B r i t i s h precedent. The concept of residence w i l l be looked at separately f o r i n d i v i d u a l s and corporations under both common law and statutory r u l e s . 10 1. INDIVIDUALS A. Common Law The f i r s t test was that of the " s e t t l e d or usual abode' used i n the English cases of Levene v. I.R.C.^ and of C.I.R. v. Lysaght^ 3. Both decisions pointed out that there was some d i f f e r e n c e between 'resident" and " o r d i n a r i l y resident"; such d i s t i n c t i o n , i f any, was necessary f o r the words of the B r i t i s h Act, but i t seems then to have been rejected by Canadian jurisprudence although the statutory r u l e s t i l l employs both terms. The decisions which have been rendered i n Canada appear to be sometimes i n c o n t r a d i c t i o n and d i f f i c u l t to re c o n c i l e except on the point that the question of residence i s a question of f a c t to be determined i n accordance with the circumstances of each p a r t i c u l a r case. The fundamental d e c i s i o n was l a i d down i n Thomson v. M.N.R.^. A Canadian who had l e f t the country with the declared i n t e n t i o n of s e t t l i n g h i s domicile elsewhere,but who returned to Canada f o r some months i n each year and maintained a large home there, was held to be a resident by the Supreme Court of Canada, which added that i f the term resident i s given i t s f u l l e s t s i g n i f i c a t i o n the q u a l i f i c a t i o n of ordinary : becomes superfluous. The f a c t of owning a house does not always creat residence. In Russel v. M.N.R.^ the Exchequer Court found that i f one maintains a home i n Canada during h i s absence from t h i s country, there are high p r o b a b i l i t i e s that he i s considered to be a resident. On the other 11 hand, a sea captain l i v i n g i n the U.S., making voyages between that country and Canada, owning i n Canada a house occupied by his married daughter i n which he used to spend two weeks vacation a year with h i s wife, was held to be a v i s i t o r because of the lack of the degree of permanence and substance which must be present to create residence (Meldrum v. M.N.R.)? And an obiter dictum i n Thomson v. M.N.R.noted that i t would be d i f f i c u l t to hold that a n a t i o n a l of the U.S., r e s i d i n g there but occupying f o r 4-5 months of the year a summer house he owns i n Canada, i s a resident. This c l e a r l y refuses to apply the contrary g old p r i n c i p l e asserted i n the Engli s h d e c i s i o n of Cooper v. Cadwalader. Confronting such as these cases one reader might say that they c o n t r a d i c t each other, while another could contend that the d i s t i n c t i o n s l i e only i n subtle d i f f e r e n c i e s (e.g. home and house). Cases of absence from Canada because of m i l i t a r y s e r v i c e have l e d to conclusions f r a n k l y contradictory. The Tax Appeal Board pronounced that an a i r force o f f i c e r l i v i n g abroad i n rented quarters and not keeping 9 a home i n Canada was o r d i n a r i l y resident i n Canada (Avent v. M.N.R.). Two years l a t e r i n the well-known case of Beament v. M.N.R.the Supreme Court of Canada decided, reversing the de c i s i o n of the Exchequer Court, that the appellant, a non-active partner of an Ottawa law f i r m during h i s m i l i t a r y s e r v i c e i n England, was not resident i n Canada because of his f i r m i n t e n t i o n to leave t h i s country. An i n d i v i d u a l who, because of his work i s not present i n Canada, may yet be declared resident i n Canada. This has been pointed out i n two recent 12 decisions i n which the Tax Appeal Board continued to show a preference f o r the dual concept of residence and ordinary residence, which i s apparently i n c o n f l i c t with the r a t i o decidendi of the Thomson case. In favour of the Board's judgments i t may be argued that this d i s t i n c t i o n s t i l l appears i n the statute and that the case law ought to be i n harmony with the c o d i f i e d r u l e s . In Hol l y Recker v. M.N.R^It was s a i d that the appellant,whenever on a job outside Canada, always returned, 12 never s e t t i n g up residence elsewhere.And i n Koricjmv^M^N. a c i v i l servant posted by the government to Japan, where he spent three years, was held o r d i n a r i l y r e s i d e n t i n Canada since the nature of h i s appointment in d i c a t e d that he would return to Canada eventually, such appointments being n e c e s s a r i l y l i m i t e d . Support was found i n the e a r l y English precedent of Lysaght v. C.I.R. Those taxpayers who leave Canada intending to s e t t l e themselves i n another country are not residents at l e a s t during the time they l i v e elsewhere. A salesman l i v i n g i n Canada decided to s e l l h i s house and to move with his family to the U.S. to engage i n h i s own new business venture. A f t e r four months, during which he sustained l o s s e s , he chose to come back to Canada, where he sought to deduct those losses from h i s income. The Tax Appeal Board, following the r a t i o of Beament v. M.N.R. decided that the taxpayer was not resident i n Canada during those four months because of h i s f i r m i n t e n t i o n to leave the country. Consequently, i t disallowed 13 the deduction of the losses suffered i n the U.S. (N. 416 v.M.N.R) Reversing an unfortunate d e c i s i o n of the Board, the Exchequer Court 13 judged that the executive of an American company, who had resided f o r three years i n Canada and who, being r e c a l l e d to the U.S., l e f t h i s wife and his son i n Toronto i n order to s e l l t h e i r house, was not resident i n Canada. In f a c t , the Court s a i d , he had completely divorced himself from hi s Canadian residence. The presence of h i s family was only to f a c i l i t a t e the sale of the house. The car and bank accounts they had were simply the consequence of the steps taken to dispose of the house (Schujahn v. M.N.R.) 1 4. The task of summarizing the p r i n c i p l e s and c r i t e r i a used to a s c e r t a i n whether one i s resident at a given place i s not a simple one at a l l , some cases being d i f f i c u l t to r e c o n c i l e with others. As already mentioned, the question of residence i s a problem of f a c t and the term 'resident" i s to be i n t e r p r e t e d i n accordance with i t s usual meaning. I t i s important to s t r e s s that , for the purposes of tax l e g i s l a t i o n , an i n d i v i d u a l must at a l l times have a place of residence (Thomson v. M.N.R.)and that he may be resident i n more than one place at the same time. I t Is almost impossible to enumerate a l l the f a c t s which may be relevant as a means of e s t a b l i s h i n g residence.However, these may include : the time spent i n a place, the manner i n which i t i s spent, the property owned and the manner i n which i t i s maintained, the family contacts, the business and s o c i a l r e l a t i o n s , the mode of l i f e r e l a t e d to a place. Their s i g n i f i c a n c e may change from case to case,for c a r e f u l consideration of the circumstances i s necessary. The general p r i n c i p l e which synthesizes the d i f f e r e n t c r i t e r i a i s s t i l l that stated by the Supreme Court of Canada 14 i n Thomson v. M.N.R. : " I t i s important only to a s c e r t a i n the s p a t i a l bounds within which he spends his l i f e or to which his ordered or customary l i v i n g i s r e l a t e d . . . ... that q u a l i t y i s c h i e f l y a matter of degree to which a person i n mind and f a c t s e t t l e s into or maintains or c e n t r a l i z e s his ordinary mode of l i v i n g with i t s accessories i n s o c i a l r e l a t i o n s , i n t e r e s t s and conveniences at or i n the place i n question". F i n a l l y , i t may be noticed that loss of residence i s more d i f f i c u l t to prove than a c q u i s i t i o n . Once residence has been c l e a r l y e s t a b l i s h e d , i t may be impossible to convince a court that i t has been removed. It i s r e l a t i v e l y easy to persuade a court that residence has been acquired i n Canada. This may explain the r u l e that an i n d i v i d u a l may be resident of more than one place at the same moment^? B. Statute ( i ) In General The term "resident i n Canada" appears at f i r s t i n s.2(1)1.T.A. whereby i t creates general tax l i a b i l i t y . It i s acknowledged that this p r o v i s i o n r e f e r s to both the common law residence and the statutory residence. Under s.250 the new Income Tax Act a t t r i b u t e s to the concept of resident an extended meaning by p r e s c r i b i n g when a person s h a l l be deemed to have been resident i n Canada. 15 According to s.250(1)(a) the person s h a l l be considered resident who has sojourned i n Canada i n the year f o r one or several periods t o t a l i n g at l e a s t 183 days. As the deemed residence counts throughout a taxation year the taxpayer has to remit the income tax on his world income f o r the whole taxation year. As under the old l e g i s l a t i o n , t h i s rule might c o n f l i c t with the " s p l i t - r e s i d e n c e 1 1 p r o v i s i o n of s.114 I.T.A. (s.29 o l d Act) concerning i n d i v i d u a l s who, a r r i v i n g i n or leaving Canada during the year, pay only an income tax apportionate to the period of residence i n Canada i n the year. I t has, however, been suggested^ that the 183 days rule only applies to a sojourner who i s not a resident but who, because of his intermittent presence i n Canada, i s deemed to reside there, whereas the residents i n the usual sense are subjected to s.29 old Act (s.114 I.T.A.) when they change t h e i r s i t u a t i o n i n the course of the year. Another class of deemed residents i s constituted by members of the Cana- dian Forces, by diplomats, c i v i l o f f i c e r s and servants working for the f e d e r a l government, by p r o v i n c i a l o f f i c e r s or servants who were residents i n Canada immediately p r i o r to appointment. Also included are persons who perform services i n a f o r e i g n country under a prescribed i n t e r n a t i o n a l development assistance program of the Canadian government, and who have been resident i n Canada at any time i n the 3 months' period preceding the beginning of the services [s.250(1)(b) to (d) I.T.A.]. So, under the o l d system, a construction engineer working i n Burma on a Colombo Plan project was held to f a l l w ithin s.139(3)(ca)old Act and consequently deemed to be a resident (Petersen v. M.N.R.)^. One may wonder why i n the recent case of Korican already c i t e d the Tax Appeal Board conside- 16 red i t necessary to go back to the idea of ordinary resident rather than simply apply s.139(3)(c)old Act, as the appellant was a customs o f f i c e r . In the l a s t category are grouped the spouses of or the persons l i v i n g with the deemed residents of ss. (b) to (d). However, persons i n t h i s category must themselves have been resident i n Canada i n any previous year, as must the c h i l d r e n of the same deemed residents [s.250(1)(e) and (f) I.T.A.]. The provisions concerning constructive residence enable one to under- stand why the Tax Appeal Board, f o l l o w i n g the l i n e of English case law, quite recently placed emphasis on the notion of ordinary residence. In f a c t s.250(3)1.T.A. [s.l39(4)old Act] reads that a reference to r e s i - dents includes persons o r d i n a r i l y r e s i d i n g i n Canada. Such p r o v i s i o n , however, appears superfluous a f t e r the judgment of the Supreme Court of Canada i n Thomson v. M . N . R T ( i i ) S p l i t - r e s i d e n c e S.114 I.T.A., s i m i l a r to s.29 old Act, provides that i n d i v i d u a l s who have been resident i n Canada only during part of the year are to be treated as residents f o r only that part of the taxation year. Their taxable income f o r the year i s the amount of income earned during that portion of the year spent i n Canada; and i t i s subject to the normal tax rates. This provision i s mainly intended to o f f e r r e l i e f to immi- 17 grants a r r i v i n g i n and emigrants leaving Canada. As already seen, the po s s i b l e c o n f l i c t with the 183 days r u l e f or sojourners could be avoided by applying the part-time residence p r o v i s i o n only f o r those who are resident i n the usual sense. It i s submitted that s.114 I.T.A. also applies to the deemed residents of s.250(1), except the sojourners, s.250(2)1.T.A. reading that the deemed residents ceasing to be such during the year s h a l l be considered residents i n Canada f o r the part of the year preceding that time. There are some d i f f e r e n c i e s between s.114 I.T.A. and s.29 o l d Act as to the computation of income, e s p e c i a l l y because of the i n c l u s i o n i n the taxpayers' income of some new items such as c a p i t a l gains. According to the new Act the taxpayer's income comprises: any income f o r the period during which he was resident; taxable c a p i t a l gains (exceeding $ 2,500) from d i s p o s i t i o n s of property, other than taxable Canadian property, which are deemed to have taken place when the i n d i v i d u a l leaves Canada —which cons t i t u t e s a new p r o v i s i o n [s.48(1)I.T.A.] :—; amounts taxable as income earned i n Canada i f he had not been resident at a l l and i f he had f a l l e n w i t h i n s.2(3) and s, 115 I.T.A.(such as deferred business pro- f i t s , deferred c a p i t a l gains, grants and remuneration while on leave) — e q u a l l y new—. S.29 old Act prescribed that payments l i s t e d i n S.31A. i . e . superannuations - pensions - retirement allowances - amounts from deferred p r o f i t sharing plan, be included i n the part year's income. This i s no longer necessary, f o r such payments are now subject to the withholding tax provided by Part XIII I.T.A. c o l l e c t e d on revenue received 18 by non-residents. The c a l c u l a t i o n of deductions to be made i n order to determine taxable income continues to be as i t was under the o l d Act. Some deductions may reasonably be considered wholly a p p l i c a b l e , whereas other deductions e s p e c i a l l y personal exemptions, may be allowed only i n part. The assessment depends upon m i n i s t e r i a l d i s c r e t i o n . The Tax Appeal Board affirmed an assessment allowing only ten twelfths of the personal exemptions(marital status and dependent person) i n the case of a taxpayer who resided i n Canada f o r only ten months (Gray v. M.N.R.)1? 18 It may be noticed that the cases N.416 v. M.N.R. and Schujahn v. M.N.R. i n which the taxpayers were recognized as being non-residents f o r a part of the year, were i n f a c t both connected with s.29 o l d Act ins o f a r as t h e i r residence i n Canada was l i m i t e d to the other part of the year. 2. CORPORATIONS A. Common Law English case law i s even more important f o r e s t a b l i s h i n g the residence of companies than i t i s f o r i n d i v i d u a l s . In the early case De Beers 19 Consolidated Mines Ltd. v. Howe the House of Lords reasoned that the question of residence of a company i s to be solved by drawing an analogy with the residence of an i n d i v i d u a l , although a company cannot eat or sleep. Thus i t was decided that the test of residence has to be not where the company i s re g i s t e r e d but where ' i t keeps house and does i t s r e a l business", the r e a l business being c a r r i e d on where the c e n t r a l management and control a c t u a l l y abides. Being a mere question of f a c t , i t i s to be determined upon a scru t i n y of the course of the business and 19 trading and not according to regulations or by-laws. The place of c e n t r a l management and control i s generally where the d i r e c t o r s and the company hold t h e i r s meetings and the conduct of the a f f a i r s i s decided. This fundamental c r i t e r i o n was confirmed i n Egyptian Delta Land & Investment Co. Ltd. v. Todd , where i t was judged that the residence of a company, whether B r i t i s h or not, i s preponderantly i f not e x c l u s i v e l y established by i t s r e a l business' l o c a t i o n . This c r i - t e r i o n was then followed i n a l l future decisions regarding the residence of companies. Reasserting the analogy between i n d i v i d u a l s and companies, the House of 21 Lords held i n Swedish Central Railway Co. Ltd. v. Thompson that a company may have residence f o r tax purposes i n two j u r i s d i c t i o n s when, as i n this case, the management of a company at i t s highest l e v e l i s i n f a c t divided . However, the High Court of A u s t r a l i a warned that a f i n d i n g on possible dual residence of a corporation should not be made unless the c o n t r o l of i t s general a f f a i r s i s r e a l l y divided among two countries or 22 more (K o i t a k i Para Rubber Estates Ltd. v. Federal Commissioner f o r Taxation ). But the p r i n c i p l e of a possible dual residence was strengthened i n Union 23 Corporation Ltd. v. I.R.C. where, a f t e r appreciating the precaution suggested by the A u s t r a l i a n Court, i t was held that the c e n t r a l management and c o n t r o l may be divided, and that such d i v i s i o n , being a matter of fact and degree i n each case, i s not denied by the circumstance that the supreme command, the power of f i n a l arbitrament, may be found to be, or to be predominantly, i n one place. 20 This p r i n c i p l e was applied i n the Canadian d e c i s i o n of Crossley Carpets (Canada) Ltd. v. M.N.R. . The company, incorporated i n England,which had taken over a business established i n Canada, managed i t s a f f a i r s i n Canada, and merely had held formal meetings i n the U.K..Crossley Carpets was held to have at l e a s t two residences. One was Canada, the a c t u a l place of management, i n which were the manager's residence, bank accounts, audi- tors and s o l i c i t o r s . England was only the place of the de jure c o n t r o l . The various elements r e l a t e d to company residence were again examined by 25 the House of Lords i n Unit Construction Co.Ltd. v. Bullock. While admitting doubts about the analogy between residence imputed to i n d i v i d u a l s and r e - sidence imputed to companies (Lord R a d c l i f f e ) , the House put emphasis on the f a c t u a l and concrete acts of management as means of e s t a b l i s h i n g the l o c a t i o n of c e n t r a l management and c o n t r o l , whether such acts are i r r e g u l a r or unauthorized or unlawful according to the corporation's c o n s t i t u t i o n . This test was followed i n Canada , j u s t as i n the case of 26 Crossley Carpets Ltd. c i t e d above, i n Yamaska Steamship Co. Ltd. V v M.N.R.. Yamaska, incorporated i n Canada before 1948, was found not to be resident i n Canada. Although the d i r e c t o r s l i v e d i n Canda, a l l decisions were made by the c o n t r o l l i n g shareholders i n London. A more l e g a l i s t i c s o l u t i o n was reached i n the case of Bedford Overseas 27 Freighters Ltd. v. M.N.R.. The Exchequer Court considered that a company incorporated i n Canada and l a r g e l y owned by a non-resident i n which, however, the d i r e c t o r s abiding i n Canada "negotiated 1 1 and signed agreements and cheques f o r the company, was resident i n Canada. A f t e r s t r e s s i n g that the d i r e c t o r s are not the agents of the shareholders the Exchequer Court ex- 21 plained that the management and c o n t r o l l i n g power of Bedford was exer- cise d by the persons i n whom i t was l e g a l l y vested, a l b e i t i n large mea- sure to carry out the owner's i n s t r u c t i o n s and the p o l i c y decisions made by him elsewhere. According to very recent Canadian jurisprudence the existence of a "head o f f i c e " i n t h i s country does not n e c e s s a r i l y imply that the company- w i l l be judged to be resident i n Canada. Take the case of Tara Exploration, incorporated i n Canada, but whose sole business was exploring f o r minerals i n Ireland and whose d i r e c t o r s were l i v i n g and a c t i n g there. Tara had a "head o f f i c e " , kept books and held some meetings i n Toronto (as consequence of the incorporation i n Canada), had r a i s e d c a p i t a l on the Canadian market, and had even embarked on a business adventure i n Canada. Notwithstanding a l l t h i s , the seat of i t s c e n t r a l and a c t u a l management was held to be i n Ireland, and Tara, therefore, as being neither resident nor d u a l l y resident 28 i n Canada (Tara Exploration & Development Co. Ltd. v. M.N.R.). Before c l o s i n g t h i s review of English and Canadian decisions i t may be u s e f u l to note the Canadian case of The King v. B.C. E l e c t r i c Railway Co. Ltd. u l t i m a t e l y examined by the Privy Council. The Exchequer Court asserted that the term n a t i o n a l i t y i n s o f a r as i t i s a p p l i c a b l e to companies, i s determi- ned by the country of incorporation. Apart from t h i s issue the case es t a - b l i s h e d that the expression "Canadian debtor" of the Income War Tax Act, with reference to withholding tax, meant debtor r e s i d i n g i n Canada. 22 B. Statute As i n the case of i n d i v i d u a l s , the notion of residence of companies i s widely extended by some statutory d e f i n i t i o n s . Any company incorporated i n Canada a f t e r A p r i l 26, 1965 s h a l l be deemed to be resident i n Canada. The simple and formal aspect of the incorpo- r a t i o n creates residence [s.250(4)(a)I.T.A.] regardless of where the r e a l business i s done or where the d i r e c t o r s a c t . If the company has been incorporated i n Canada before A p r i l 27, 1965 then the company i s considered to reside i n Canada i f at any time i n the taxation year or i n any preceding year (ending a f t e r A p r i l 26, 1965) i t has been resident i n Canada or has c a r r i e d on business i n Canada [s.250(4)(c)I.T.A.]. When reading resident the Act obviously means common law resi d e n t . It i s submitted that there i s not any requirement that the company c a r r i e s out a l l i t s business i n Canada and, therefore, i t s u f f i c e s that some business be done there i n order to e s t a b l i s h Canadian corporate residence. Both provisions exactly correspond to the old Act £s.l39(4a)]. But the new l e g i s l a t i o n also creates a new cl a s s of deemed resident corporations. This c l a s s i s constituted by fore i g n business corporations (s.71 old Act) which were such on June 18, 1971. During the ten years preceding that date they must have c a r r i e d on business i n a country other than Canada; must a l s o have been incorporated i n Canada before A p r i l 9, 1959 [see s.71(5)old Act] and have been resident or doing business i n Canada [s.250(4)(b)I.T.A.]. 23 The deemed residence of s.250(4)1.T.A. applies throughout an e n t i r e taxation year and the company i s assessed on i t s world income according to s.2(l) and s.3 I.T.A.. 30 It was very recently judged (The Deltona Co. v. M.N.R.) that a corporation amalgamated a f t e r A p r i l 26, 1965, whose c e n t r a l management and c o n t r o l was i n the U.S. and which had not c a r r i e d on any business i n Canada, was a company deemed to reside i n Canada, f o r the amalgamation i t s e l f c o n s t i t u t e d an incorporation within the meaning of s.139(4a)(a)old Act. Canadian corporation The B i l l introduces a new concept of Canadian corporation which, i n connection with the t o p i c of t h i s paper, i s of c e n t r a l concern when dealing with the a d d i t i o n a l 25 % (or, u n t i l 1975, 15 %) branch tax. According to s.89(1)(a)I.T.A. there are two classes of companies com- ply i n g with t h i s terra. F i r s t , any company incorporated i n Canada, no matter when, and resident i n Canada at the relevant time. Second, any corporation resident i n Canada throughout the period s t a r t i n g June 18, 1971, and ending at the relevant time. However, f o r the purposes of tax-free d i s t r i b u t i o n of dividends out of tax-paid undistributed surplus or 1971 c a p i t a l surplus [s.83(1)I.T.A.], a company that was incorporated i n Canada before A p r i l 27, 1965 [see s.250(4)(c)I.T.A.] and was not resident there at the end of 1971 may not be considered a Canadian corporation. 24 3. CONCEPTUAL COMPARISON WITH CERTAIN OTHER COUNTRIES Taxpayers who(for Canadian tax purposes) are non-residents in Canada must be considered to reside in some other country. The concept of residence is not necessarily used in every country, for general tax l i a b i l i t y may rest on other bases. Taxation systems and kinds of taxes levied vary greatly from one country to another. When used, the term of residence may apply to notions other than that of residence in the sense used by Canadian and English law. Differencies exist not only between common law and c i v i l law countries but also among c i v i l law jurisdictions, because of different tax structures and national c o d i f i - cations . Therefore i t w i l l be of interest to give a brief summary of the situation as i t exists i n a few other countries. Western Germany German tax legislation distinguishes between taxpayers with ''unlimited" tax l i a b i l i t y who pay tax on the whole income from German and foreign sources, and taxpayers with "limited" l i a b i l i t y only taxed on income from German sources. For individuals the unlimited taxability is determined by : a) "domicile" (Wohnsitz), which is the place where individuals occupy a residence in a manner indicating that they w i l l use and retain i t on a non-temporary basis; b) "costumary place of abode" (gevoehnlicher Aufenthalt), which is the location where they are physically present under circumstances showing that the presence is not merely temporary, place of abode also being created by staying in Germany over six months. 25 For corporations or other e n t i t i e s : a) the seat or statutory o f f i c e C S i t z ) , which i s the place where the corporate body i s l i s t e d i n the o f f i c i a l r e g i s t e r (necessarily i n Germany i f the company i s organized under German law); b) the "place of management" or centre from which i t s a c t i v i t i e s are d i r e c t e d . France Individuals having t h e i r "domicile'(domicile) i n France are taxed on income from both French and fo r e i g n sources; an exemption f o r t h e i r f o r e i g n income i s granted to i n d i v i d u a l s who are nationals of a country taxing i t s c i t i z e n s abroad (the t y p i c a l example being the U.S.). Domicile i s determined through : i ) centre of i n t e r e s t s , i . e . l o c a t i o n of the taxpayer's major economic a c t i v i t i e s with a character of permanence and s t a b i l i t y , or the l o c a t i o n of the major portion of t h e i r wealth: i i ) p r i n - c i p a l residence (sejour p r i n c i p a l ) f o r more than f i v e years and personal presence i n France during most of that time (even without permanent dwelling). Non-resident i n d i v i d u a l s are taxable on income from sources within France defined i n the Tax Code. Individuals may belong to a t h i r d c l a s s i f , without being domiciled, they maintain a ''secondary residence" and so are l i a b l e to tax on the ac t u a l income from c e r t a i n French sources or to an amount equal to f i v e times the r e n t a l value of the residence. Residence of a corporation i s established by the l o c a t i o n of the head o f f i c e ( siege s o c i a l ) , generally corresponding to that designated i n the charter of incorporation (si£ge s t a t u t a i r e ) . I f the l a t t e r i s only f i c t i t i o u s then the head o f f i c e i s located where the a c t u a l management 26 i s centered and c a r r i e d on (siSge e f f e c t i f ) . Resident companies and other organizations are taxable on t h e i r world income except the income from a c t i v e business done abroad. Non-resident e n t i t i e s are taxed on t h e i r French income, and must also remit a tax on dividends d i s t r i b u t e d by them and derived from the earnings ob- tained from business i n France. I t a l y The concepts of residence or domicile are p r a c t i c a l l y useless i n I t a l i a n taxation as the l e g i s l a t i o n has attempted to create a system taxing a l l the new wealth produced i n the country i n the year (the : n a t i o n a l product"). The place of t a x a b i l i t y i s the place where an income producing f a c t o r (source of income) i s used: t h i s p r i n c i p l e i s c a l l e d t e r r i t o r i a l i t y . To determine the l o c a t i o n of a source of income several c r i t e r i a are employed: l o c a t i o n of property, place of exercise of a c t i v i t y , domicile or residence of payor and place of creation of o b l i g a t i o n to pay income. For i n d i v i d u a l s the o b j e c t i v e taxes (imposte r e a l i ) . composed by four d i f f e - rent taxes, and the personal taxes (imposte complementari) are l e v i e d , r e - gardless of residence, on income from I t a l i a n sources, with some r e s t r i c t i o n s concerning foreigners i n I t a l y and I t a l i a n s abroad. Companies pay the corporate tax constituted by a tax on the assets of the e n t i t y (paid-up c a p i t a l + reserves) — a true wealth tax — and a tax on the income exceeding the "normal p r o f i t " (6% of the assets value), with the r e s t r i c t i o n on foreign companies to assets devoted to operations i n I t a l y and income refer a b l e to those assets. 27 Sweden Sweden l e v i e s two income taxes: a n a t i o n a l one and a municipal one. Residents pay both taxes on t h e i r world-wide income. Non-resident taxpayers s u f f e r taxes on income from both r e a l property and business i n Sweden; they also s u f f e r withholding taxes. Individuals do reside i n Sweden when they make there t h e i r " r e a l dwelling and home", when they intend to become residents, or when they make t h e i r "permanent sojourn" i n the country. For companies the only test i s the incorporation; i f incorporated e l s e - where the e n t i t y i s non-resident. Belgium Taxpayers who are "inhabitants of the Kingdom" (both i n d i v i d u a l s and l e - g a l e n t i t i e s ) are taxable on t h e i r world income, while those who are not inha- bitants only pay on income from Belgium .and on income received i n Belgium. A taxpayer i s an "inhabitant" i f he has there h i s " f i s c a l domicile" or his "seat of a f f a i r s " , the l a t t e r being s p e c i a l l y important f o r corpora- tio n s . The f i s c a l domicile i s a concepte considering the residence but attaching more importance to circumstances than to an i n d i v i d u a l ' s i n t e n t i o n s . The seat of a f f a i r s i s the place of the p r i n c i p a l admini- s t r a t i v e establishment; but incorporation i n Belgium s u f f i c e s to have a company domiciled there. Switzerland The tax system of Switzerland i s organized at three l e v e l s -- f e d e r a l , 28 cantonal (the states of the Swiss Confederation are c a l l e d cantons) and municipal — and a l l three p o l i t i c a l e n t i t i e s levy income and net wealth taxes. The cantonal taxes are the most important. Therefore, i t i s impossible to define a Swiss system as such f o r any cantons l e - g i s l a t e according to t h e i r own needs. Some general c r i t e r i a apply, however, i n almost every j u r i s d i c t i o n . Taxpayers with unlimited tax l i a b i l i t y (assujettissement general) s u f f e r taxes on t h e i r world income, while those with l i m i t e d l i a b i l i t y (assujettissement l i m i t ! ) pay on t h e i r income from Swiss sources (often through the a n t i c i p a t o r y tax, which i s a f e d e r a l withholding tax). General t a x a b i l i t y f o r i n d i v i d u a l s r e s u l t s from permanent residence (domicile f i s c a l ) , which i s the centre of l i f e i n t e r e s t s and r e l a t i o n s ; temporary residence f o r more than s i x months (or more than three months i f they own a residence); temporary residence, even for le s s than s i x months, i f the i n d i v i d u a l s engage i n a g a i n f u l a c t i v i t y ( a c t i v i t e l u c r a - t i v e ) . I t should be added that temporary residence creates t a x a b i l i t y r e t r o a c t i v e l y . Corporations are unlimitedly l i a b l e on the basis of incorporation i n Switzerland together with l o c a t i o n of the centre of management and, e s p e c i a l l y , on the basis of permanent establishment i n the country. Foreign companies having a permanent establishment i n Switzerland (broadly defined) are l i a b l e to taxes on the income and assets of i t with an apportionement of such elements to the whole undertaking of the e n t i t y . The same i s v a l i d f o r Swiss companies having a permanent establishment abroad, with some l i m i t a t i o n s . Special treatment i s generally granted to s p e c i a l companies, such as holding or service corporations. 29 I I I . ACTIVE BUSINESS INCOME EARNED IN CANADA BY NON-RESIDENTS As stated at the beginning of t h i s paper non-residents are l i a b l e to taxes on t h e i r income earned i n Canada — s . 2 ( 3 ) 1 . T . A . — . One of the most important sources of income f or non-residents i s c a r r y i n g on business i n Canada. S.2(3)(b)I.T.A. e f f e c t i v e l y reads that when a person c a r r i e s on business i n Canada he has to pay Canadian income tax. 1. CARRYING ON BUSINESS IN CANADA A. Business Business i s a very widely used word often appearing i n the tax l e g i s l a t i o n and covering various gain producing a c t i v i t i e s . In the o l d English case 31 of Smith v. Anderson the Chancery D i v i s i o n decided that anything occupying the time, the at t e n t i o n , the labour of a man for the purpose of earning a p r o f i t i s included i n the concept of business. A few years l a t e r i t was also held that "business" i s a much l a r g e r word than "trade" 32 (Rolls v. M i l l e r ) . A s i m i l a r p o s i t i o n appeared i n the Canadian jurisprudence, where the emphasis was put on the prospect of gain or 33 p r o f i t (Samson v. M.N.R.) . In the present Canadian tax law the word "business" has a very broad meaning and some assistance can be found i n s.248 I.T.A. [s.139(1) (e)old Act which reads: 30 "Business includes a p r o f e s s i o n , c a l l i n g , t r a d e manufacture and undertaking of any kind whatever and includes an adventure or concern i n the nature of trade but does not include an o f f i c e or employ- ment". B. Carrying on Business i n Canada 34 In Erichsen v. Last i t was held that when a person h a b i t u a l l y does a thing capable of producing a p r o f i t then he i s c a r r y i n g on a trade or business. In the same case i t was then said that the question of knowing whether a person c a r r i e s on business i s e s s e n t i a l l y a question of f a c t to be answered i n accordance with the circumstances of each case a s " c a r r y i n g on of a trade i s a compound f a c t made up of a v a r i e t y of things". As to c a r r y i n g on business i n Canada by non-residents some assistance can be found by reading s.253 I.T.A. [s.l39(7)old Act] which provides: "When, i n a taxation year, a non-resident person a) produced, grew, mined, created, manufactured, f a b r i c a t e d , improved, packed, preserved or con- structed, i n whole or i n part, anything i n Ca- nada whether or not he exported that thing without s e l l i n g i t p r i o r to exportation, b) s o l i c i t e d orders or offered anything for s a l e i n Canada through an agent or servant whether the contract or transaction was to be completed i n s i d e or outsied Canada or p a r t l y i n and p a r t l y outside Canada he s h a l l be deemed, for the purposes of t h i s act, to have been carrying on business i n Canada i n the year". 31 The common law courts have not r e a l l y established a c l e a r test permitting one to say when business i s done i n a country. They have, i n varying cases,given emphasis to the place where p r o f i t producing contracts 35 are concluded (Grainger & Son v. Gough ; Firestone T i r e & Rubber Co. of Canada Ltd. v. C.I.T.36), where the work i s done or the goods are 37 38 del i v e r e d (Smidth & Co. v. Greenwood ; Belfour v. Mace ), where pay- ments are made, where the p r i n c i p a l objects of transactions but not the a n c i l l a r y a c t i v i t i e s are performed. A l l these p r i n c i p l e s have been superseded or overruled by the s t a t u - tory p r o v i s i o n s , the r e s u l t of which i s to c l a s s i f y a wide range of a c t i v i t i e s as deemed to be c a r r y i n g on business i n Canada. The i n t e r p r e t a t i o n of these provisions offered the Canadian courts the opportunity to give some i l l u s t r a t i o n s of the bear of these p r o v i s i o n s . As most of the cases deal with the problem of c a r r y i n g on business i n Canada, e i t h e r through an agent or i n r e a l estate investments, they w i l l be examined under the paragraphes r e l a t e d to those questions. However, the important case of United Geophysical Co. of Canada v. M.N.R."̂  should be looked at immediately. An american corporation which used to conduct a business i n both the U.S. and Canada incorpo- rated a wholly-owned subsidiary . The subsidiary assumed the Canadian part of the business by a c q u i r i n g and "renting" the parent's equipment. The parent corporation had nothing more i n Canada but the "rented" assets. It e f f e c t e d s e r v i c i n g and r e p a i r i n g , and provided supplementary equipment, a l l that at cost. The Exchequer Court decided that e i t h e r the 7 32 " r e n t a l " only c o n s t i t u t e d an income from property, i n which case i t i s immaterial whether the parent did business i n Canada; or, i n a more co r r e c t view, the parent company was e f f e c t i v e l y carrying on business i n Canada (as defined i n s.l39(7)old A c t ) . Moreover, the " r e n t a l " i t received was income from the business c a r r i e d out i n the U.S. and not from that part of i t s business done i n Canada, f o r the equipment was deli v e r e d i n the U.S. and the payments were determined and received i n the U.S.. They d i d not r e s u l t i n any proximate sense from rendering services i n Canada. The " r e n t a l " flowed to the parent from the h i r i n g of the equipment and was, therefore, i n i t s nature l i a b l e to withholding tax. In 1962 an author made an attempt to enumerate the p r i n c i p a l i n d i c i a of "carrying on business i n Canada" 4^: 1. the maintenance i n Canada of a p h y s i c a l establishment such as a branch o f f i c e or fa c t o r y ; 2. the maintenance of a stock of goods i n Canada, from which d e l i v e r i e s to customers are regurarly made; 3. the h a b i t u a l making of contracts i n Canada by the non-resident, or an agent or servant of the non-resident; 4. the production, growing, mining, manufacture, f a b r i c a t i o n , improvement, packing, preserving or construction of anything i n the whole or i n part i n Canada; 5. the rendering of serv i c e s i n Canada. He also suggested that a non-resident can be sa i d to be "carrying on b u s i - ness" not only i f he trades i n Canada i n the ordinary way but also i f he engages i n an adventure i n the nature of trade. This p o s i t i o n seemed to 33 find a j u d i c i a l confirmation in Thea Co. v. M.N.R.4^ in which an individual non-resident was held to be carrying on business in Canada because a com- pany, that was considered as his agent, had engaged in an adventure in the nature of trade. The position also seemed to find confirmation i n Ann Neuberger v. M.N.R. where i t was said that "the carrying on of a business comprises even a single adventure in the nature of trade". But the Exchequer Court decided the contrary in Tara Exploration & Deve- lopment Co. Ltd. v. M.N.R. , tentatively holding that an adventure in the nature of trade did not in i t s e l f constitute "carrying on business", as i t was not part of a larger activity and as i t has never been said that an isolated transaction f a l l s within s,139(7)old Act. It a l s o asser- ted that s.139(1)(e)old Act did not operate a substitution of 'adventure in the nature of trade" for "business" in the provisions (particularly s.2(2)old Act) creating the tax l i a b i l i t y of non-residents. Probably i n consideration of such decision, the Tax Appeal Board held that a nen-resident who had participated in a number of real estate transactions had carried on business in Canada, pointing out that he was engaged in a series of adventures in the nature of trade which constitutes a business ac t i v i t y quite distinct from a single or isolated venture involving one purchase and sale.(Heskel Abed v. M.N.R.)43* Both last cases could imply the consequence that the gains arising from the sale of capital assets would be treated as capital gains when concerning a non-resident, whereas they may be considered as income(as revenue from an adventure in the nature of trade) when concerning a resident. 43b The meaning "in Canada" is defined i n s. 255 I.T.A. . 34 C. Carrying on Business through an Agent Non-residents can carry on business i n Canada through an agent(or an employee) acting on t h e i r behalf. This was already recognized i n some o l d B r i t i s h cases where non-residents of the U.K. were held to exercise t h e i r trade i n the U.K. through t h e i r agents and representatives a c t i n g there (Watson v. Sandie H u l l ^ ; Turner (Leicester) Ltd. v. Rickman^5; Wilcock v. Pinto & C o ^ ; Belfour v. Mace^) and there performing on behalf of t h e i r foreign p r i n c i p a l s one or some of the e s s e n t i a l i a c t i v i t i e s necessary to t h e i r p r i n c i p a l s ' businesses. In the present Canadian l e g i s l a t i o n , however, s.253(b)I.T.A. [s.139(7) (b)old Act] establishes a much broader tax b a s i s , since mere s o l i c i t a t i o n of orders or o f f e r i n g goods f o r sale through an agent or servant s u f f i c e s to have business c a r r i e d out i n Canada by non-residents. One of the major problems i s i n knowing whether the representative i s an agent of a non-resident p r i n c i p a l or an indipendent contractor doing h i s own business. The question i s very important because only i n the f i r s t case w i l l there be t a x a b i l i t y of the non-resident under s.253(b). The answer w i l l depend on the degree of c o n t r o l that non-resident exercises 48 on h i s representative's a c t i v i t i e s (Standard Fashion Co. v. McLeod) Anyway the mere f a c t that the r e l a t i o n s h i p between the Canadian represen- t a t i v e and the non-resident i s r e f e r r e d to as one of agency i s not deter- minant and the issue i s to be solved by means of general l e g a l p r i n c i p l e s ^ ? The f a c t s of each case are to be considered c a r e f u l l y . Some c r i t e r i a to deter- 35 mine whether or not there i s agency are reported by LaBrie: whether the alleged agent conducts the business in the name of the principal or i n his own name; whether the representative acts for only one prin- cipal or for several persons ."^ The problem i s far from being an easy one and the j u d i c i a l solutions are somewhat d i f f i c u l t to reconcile. In a sales tax case — Palmolive Manufacturing Ltd. v. The King~^— a Canadian manufacturing company that was the wholly dependent subsidiary of an American corporation, which also owned a Canadian distributing company, and which sold i t s products to the second Canadian company exclusively; was held merely to act as agent of the second company. But short time later the Exchequer Court asserted in another sales tax case that the fact that the two cor- porations had business relations with each other alone did not constitute 52 the f i r s t one agent of the second (The King v. B.C. Brick & T i l e Co. Ltd.) The question mainly arises in cases in w.hich a non-resident se l l s his goods in Canada through the services of a Canadian distributor. The "distributor's warehouse contract" may be one of simple purchase and resale rather than agency, as i t was decided by the Supreme Court of Canada (two judges dissenting) in the case of an extra-provincial company. This company delivered i t s products to i t s B.C. distributor. Had there been an agency the company ought to have paid provincial income tax (Firestone 53 Tire & Rubber Co. of Canada Ltd. v. C.I.T.) . Again, some tests to deter- mine whether the agreement is one as between vendor and purchaser or as between principal and agent are suggested by LaBrie : the occasion and 36 time of passing of property from the alleged p r i n c i p a l ; his l e g a l r i g h t s against goods i n the possession of the agent; h i s c o n t r o l oyer r e s e l l i n g contracts, p r i c e s and methods; the r i s k supported by the d i s t r i b u t o r . Some jurisprudence e x i s t i n d i r e c t r e l a t i o n to s.139(7)(b)old Act. In some cases the judges held that there was an agent ac t i n g on behalf of a non- -resident p r i n c i p a l who was, therefore, carrying on business i n Canada. In Ross & Co. Ltd. v. M.N.R.^ a stockbroker °f the Bahamas bought and reso l d with the cooperation of Toronto s e c u r i t i e s dealers shares of an American corporation. The Exchequer Court held that the Canadian dealers were his agents because they r e a l i z e d such a small p r o f i t percentage, which was a commision rather than a p r o f i t from dealing on t h e i r own ac- count, and because they bought shares sometimes below and sometimes above the market p r i c e , according to his i n s t r u c t i o n s . In the already mentioned case of Thea Co. v. M.N.R.^ a company was considered to be the agent of a non-resident as the l a t t e r was the brother of i t s only shareholder and he himself owned 75% of the i n t e r e s t i n a land p a r c e l whose t i t l e had been tra n s f e r r e d to the company. The company, the Tax Appeal Board said, had been intruded into the matter j u s t to serve as a v e h i c l e and to s i m p l i f y a number of things. See also with p a r t i c u l a r reference to r e a l estate i n - vestments the cases of Ann Neuberger v. M.N.R."*̂  and of Heskel Abed v. M.N.R^ Judgments have also been rendered i n which the existence of an agency r e l a - t i o n s h i p has been denied. Thus a Canadian wholly-owned subsidiary, e n t i r e - l y assuming the previous Canadian venture of i t s parent, was not recognized 37 to be the agent of the American parent, f o r there had been a c l e a r i n t e n t i o n to tran s f e r that business to another l e g a l i d e n t i t y and because the mere ownership of a l l the shares does not make the company's business that of the shareholder.(United Geophysical Co. of Canada v. M.N.R.)^ In an e a r l i e r case the Tax Appeal Board decided that the a c t i v i t y of the agent of a f o r e i g n corporation who merely disposed of the crop-shares payment, which the corporation received f o r rented farmland, was not s u f f i - c i e n t to constitute a business c a r r i e d out on behalf of the non-resident (D.H. Peery Estate Inc. v. M.N.R.)^° Summarizing, one can say that a non-resident c a r r i e s on business i n Canada — the s o l i c i t a t i o n of orders and o f f e r i n g of goods f o r sale — through an agent when he exercises a c e r t a i n c o n t r o l over h i s agent, the degree of c o n t r o l being ascertained by means of the c r i t e r i a o u t l i n e d at page 35, and when the agent's a c t i v i t y may be q u a l i f i e d as c a r r y i n g on of a business which would require i n harmony with the most recent jurisprudence more than an adventure i n the nature of trade. This l a t t e r point i s probably s t i l l open to d i s c u s s i o n . Another d i f f i c u l t question i s that of determining whether a s a l e , which would be a c a p i t a l sale and create taxable c a p i t a l gain (1/2 of the gain) when concerning a resident, becomes a business operation c r e a t i n g income when ef f e c t e d by the agent of a non-resident. The problem may be rather usual with the r e a l i z a t i o n of land investments.^ 1 One author expressed 38 the opinion that the a p p l i c a t i o n of s.l39(7)(b) old Act should lead to the conclusion that the revenue of such a sale should be treated as income, although to assess tax would seem u n f a i r and s t r i c t , the tax statutes not being open to argument of equity and f a i r n e s s . The l a s t jurisprudence considering that an adventure i n the nature of trade does not corrispond to c a r r y i n g on of a business, however, might permit one to argue that a c a p i t a l sale which i s not a business for a r e s i d e n t i s a f o r t i o r i not c a r r y i n g on business f o r non-residents. D. Carrying on Business by Owning Real Estate Frequently the issue whether a non-resident does business or not i n Canada i s r a i s e d i n r e l a t i o n with the ownership of r e a l t y and i t s d i s p o s i t i o n . Real estate i s i n f a c t the most t r a d i t i o n a l and one of the surest forms of investment and i t s return i s a t y p i c a l kind of property r e t u r n . In some circumstances one may reach the point where the landownership becomes commercial e n t e r p r i s e . The tax p o s i t i o n of the r e a l property owner completely depends on the answer given to t h i s question. If he c a r r i e s on business he i s taxable under Part I of the Act, whereas i f he simply receives income from property he i s l i a b l e to the withholding tax — P a r t XIII I.T.A.— on the gross revenue unless he chooses the a l t e r n a t i v e e l e c t i o n . It i s understood that i n the case of t a x a b i l i t y under Part I because of doing business no e l e c t i o n i s necessary. 39 I t seems that when non-residents lease farmland they own i n Canada they are not deemed to carry on business, even i f they p a r t i c i p a t e i n the farming p r o f i t s and these are c o l l e c t e d by an agent. In Peery Estate Inc. v. M.N.R. the crop-shares payments, which an American corporation received from farmland i t had rented for over twenty years to the same tenant, were s a i d to be r e n t a l income and not business p r o f i t , although the corporation had a l o c a l agent disposing of the crop-shares and 64 r e m i t t i n g the proceeds. L i k e l y i n C A . Graf von Westphalen v. M.N.R. where the farmland p a r c e l of a non-resident was rented by h i s brother-in -law (acting as h i s attorney) to a lessee who agreed to pay a r e n t a l plus a share of the net p r o f i t s , the Board held that the income was only the r e s u l t of a landlord-tenant r e l a t i o n s h i p as the land was not ex p l o i t e d on behalf of the owner. Non-residents owning an apartment b u i l d i n g leased f o r them by a l o c a l manager who als o c o l l e c t s the r e n t a l s are probably not i n business yet. But non-residents having two build i n g s with numerous f l a t s , stores and even a manufacturing place , looked a f t e r f o r them by a r e a l estate broker and an accountant spending a good part of t h e i r working time 65 on t h i s task, were considered to carry on business (Rubinstein v. M.N.R.) . In the case of non-residents t r a n s f e r r i n g money to Canada where the money i s used f o r continuous d e a l i n g i n land and f o r speculative repeated purchasing and r e s e l l i n g of r e a l t y , there i s no doubt that they do .66 business i n t h i s country (Ann Neuberger v. M.N.R.; Heskel Abed v. M.N.R.) 40 It so appears that i n extreme s i t u a t i o n s i t i s not too d i f f i c u l t to solve the problem, whereas i n other cases the s o l u t i o n w i l l depend on the following f a c t s : kind and number of p r o p e r t i e s , kind and number of r e n t a l contracts, type and amount of agents'work, ex c e p t i o n n a l i t y or frequency of transactions. E. Income from Carrying on Business According to s.2(3)(b)I.T.A. [s.2(2)old Act] non-residents c a r r y i n g on business i n Canada s u f f e r the Part I income tax on t h e i r taxable income earned i n t h i s country. The income from business i s the p r o f i t therefrom [s.9(1)1.T.A.]. The computation of taxable income i s made i n the same way as f o r r e s i d e n t s , some supplementary rules beeing l a i d down i n s.115 I.T.A.. From s.115(1) - s s . ( a ) ( i i ) f o r the business income — i t follows that the income of such taxpayers i s t h e i r income f o r the year as i t would be determined under s.3 so modified by s.115 i t s e l f . The section contains provisions r e l a t e d to the taxable c a p i t a l gains and to the allowable deductions, as w i l l be seen l a t e r on. T a x a b i l i t y i s established not only when non-residents do business i n the year but also when they have done i t i n a previous year. The timing extention introduced by the new B i l l — s.2(3) — a f f e c t s employment income generally computed on a cash basis rather than business revenues to which the a c c r u a l method i s a p p l i e d . The new p r o v i s i o n w i l l , however, a l s o concern some forms of business income which might be not included i n Part I income u n t i l a year a f t e r the business i s discontinued. 41 Examples are reserves f o r future proceeds on the sale of property i n the course of business, or recapture of c a p i t a l cost allowances on the s a l e i n a l a t e r year of depreciable property used i n the , . 6/ business. Computation of income from sources completely within one t e r r i t o r y i s based on assumption that the taxpayer has no income from any other t e r r i t o r y and that the admitted deductions are only the deductions which are reasonably a p p l i c a b l e , e i t h e r i n whole or i n part, to those sources : s . t ( l ) ( a ) I . T . A . [s.139(la)(a)old A c t ] . I f the business i s c a r r i e d on p a r t l y i n one place and p a r t l y i n another the same assumptions are made with p a r t i c u l a r reference to any p a r t i c u l a r place : s . f ( l ) (b)I.T.A. [ s . l 3 9 ( l a ) ( b ) ] . This rules i s completed when applying to non-residents — s . 1 1 5 — by s.4(3)1.T.A. [s.139(lb)old Actj which reads that i n such case of computing income on t e r r i t o r i a l basis a l l deductions allowed s h a l l be deemed to be a p p l i c a b l e e i t h e r wholly or i n part to sources i n a p a r t i c u l a r place. Under the old system the computation of t e r r i t o r i a l — f o r non-residents Canadian income as long as i t was i n the same t e r r i t o r y - - from a l l sources i n one t e r r i t o r y could be done a l l together,with losse s o f f s e t t i n g g a i n s ^ 8 . That i s no longer possible under the new B i l l , which prescribes L S . H ( * ) I . T . A . ] separate determination of income or loss from each source of business (or property) income. I t i s not cl e a r how e f f e c t i v e the 69 p r a c t i c a l separation of d i f f e r e n t businesses w i l l be. 42 As the only business income i s that from Canadian business operations, so the only business losses are those from businesses c a r r i e d out i n Canada[s.115(1)(c)I.T.A.]. This p r o v i s i o n replaces i n a simpler form s.31(3)old Act. In Ross & Co. Ltd v. M.N.R.70 a non resident stock- broker, who was considered ca r r y i n g on business by dealing i n s e c u r i t i e s , was disallowed the deduction of a los s s u f f e r e d i n r e l a t i o n with other s e c u r i t i e s as the l a t t e r ones were not comprised i n the trade exercised i n Canada. S.115(1) [s.31(1)(b)old Act] also provides that the only deductions permitted are those which may reasonably be considered wholly a p p l i - cable; and also such part of any other deductions as may reasonably be considered a p p l i c a b l e . The a c t u a l basis f o r an apportionment may depend on the nature of deduction which the taxpayer claims, the main fa c t o r i n the c a l c u l a t i o n being reasonableness. There i s an obvious s i m i l a r i t y with s.114 (s.29old Act) applying to part-time r e s i d e n t s , the p r a c t i c a l e f f e c t of which i s l e f t to the Department's d i s c r e t i o n . It was decided that a non-resident doing business during a whole year was e n t i t l e d to f u l l personal exemptions (Rubinstein v. M.N.R.) 7 1. Probably the text to f i x the allowable portion of deduction i s a combi- nation of l o c a t i o n and duration of the taxpayer's Canadian sources of revenue. F i n a l l y i t may ^« noticed that the general (income) averaging formula i s a v a i l a b l e to i n d i v i d u a l non-residents i n the year of averaging (taxation year) and the immediately preceding year i f they carry on business i n 43 Canada [s.118(2)1.T.A.], whereas they are denied the r e l i e f of an income averaging annuity contract (forward averaging) i n respect of which residence i n Canada i s a condition sine qua non [s.61(1)I.T.A.]. F. Ship and A i r c r a f t Operations An exception to the p r i n c i p l e that non-residents pay an income tax on the income earned from c a r r y i n g on business i n Canada i s provided by s.81(1)(c)I.T.A. [s.10(1)(c)old A c t ] . This s e c t i o n prescribes that the earnings from the operation of a ship or an a i r c r a f t i n i n t e r n a t i o n a l t r a f f i c s h a l l not be included i n the income, the con d i t i o n being that the country of residence of the said taxpayers o f f e r s a s u b s t a n t i a l l y s i m i l a r p r i v i l e g e to Canadian r e s i d e n t s . Such exemption i s not p e c u l i a r 71a to Canada and i t i s repeated i n general tax conventions as well as i n p a r t i c u l a r tax t r e a t i e s r e l a t e d to t h i s matter (e.g. with Switzerland). The words "operated by the taxpayer" have been interpreted i n a case where an Eng l i s h company owning ships had branch o f f i c e s i n Canada which provided various ser v i c e s not only to t h e i r own ships but also to subsidiaries'and other (independent) companies' ships, when they were i n Canadian waters. The Exchequer Court, subsequently affirmed by the Supreme Court of Canada, held that i n computing i t s Canadian income the company could deduct (as exempt) the part corresponding to the services rendered by the branches to the company's ships, as such earnings arose from the operation of ships owned (or chartered) by the taxpayer. 44 But the exemption did not cover the p r o f i t from the services performed f o r the s u b s i d i a r i e s ' or the other corporations' ships (Furness Withy & Co. Lt d . v. M.N.R.)711? /. COMPARISON OF METHODS A. Individuals Non-resident i n d i v i d u a l s can carry on business i n Canada e i t h e r d i r e c t l y themselves, or through t h e i r agents a c t i n g i n Canada on t h e i r behalf. According to s.2(2) and s.115(1)I.T.A. they pay taxes on t h e i r taxable income from t h e i r Canadian business. Except i n those few cases already pointed out, they <»re i n the same s i t u a t i o n as the resident businessmen. The new B i l l g r e a t l y s i m p l i f i e s the c a l c u l a t i o n of the income tax payable by .substituting a s i n g l e schedule f o r the combination of an income tax rates schedule together with various s p e c i a l taxes (old age s e c u r i t y , s o c i a l development, f o r e i g n investment, temporary sur t a x ) . For the p r o v i n c i a l tax the new system simply creates a percentage c a l c u l a - t i o n of che f e d e r a l tax instead of an abatement from the "basic tax" (s.33 o l d Act) and a new c a l c u l a t i o n . By assuming a new standard rate of p r o v i n c i a l tax at 30 % (of the f e d e r a l tax) the t o t a l income tax w i l l vary from a minimum of *2.1 % (reduced to /.8 % u n t i l 1976) f o r amounts up co $ 500 to a maximum of 61.1 % f o r amounts over S 60,000 of c h e taxable income i n the taxation yeat (s.117 I.T.A.).As some provinces w i l l ptobably introduce a percentage higner than 30 % t h e i r taxpayers 45 w i l l s u f f e r t o t a l taxes somewhat higher than the figures above. If the non-residents doing business i n Canada also own shares of Canadian corporations they w i l l not b e n e f i t from the dividend tax c r e d i t provided by s.121 I.T.A.. As i n the old l e g i s l a t i o n — s . 1 0 8 ( 9 ) — the new B i l l [s.214(13)] allows the Governor i n Council to make general or s p e c i a l regulations about the (withholding) tax — P a r t XIII I.T.A.— to be remitted by a non-resident ca r r y i n g on business i n Canada. S.805 (1) old Income Tax Regulations read that a non-resident doing business i n Canada was taxable under Part I I I o l d Act (withholding tax) on a l l amounts paid or cre d i t e d to him and normally subject to that tax, but not f o r those amounts that may reasonably be a t t r i b u t e d to h i s en t e r p r i s e i n Canada. It i s quite probable that the new Regulations w i l l contain a s i m i l a r p r o v i s i o n . Thus, unless the shares are held i n r e l a t i o n with or f o r the purpose of the business a c t i v i t y , dividends w i l l be taxed on the gross amount at the f l a t withholding rate. But i f the shares are not so held, dividends are grossed up by 1/3 and included i n the taxpayer's income — s . 8 2 ( 1 ) I . T . A . — . The computed f e d e r a l tax i s then reduced by a deductible dividend tax c r e d i t of 4/5 of the gross-up; i t i s to be hoped that the provincies w i l l allow the deduction of the remaining 1/5. Individuals may prefer another s o l u t i o n . They may incorporate, e i t h e r alone or i n cooperation with Canadian residents, any company which does business i n t h i s country. In general the company pays income tax on i t s taxable income at a f i x e d r a t e of 50 % ( d e c l i n i n g to 46 % u n t i l 46 1976) —s.123 I.T.A.— a p r o v i n c i a l tax c r e d i t of 10 % of the taxable income being deducted from the f e d e r a l corporation tax (s.124). When the company resident i n Canada d i s t r i b u t e s or i s deemed to have d i s t r i b u - ted dividends to i t s non-resident shareholders these w i l l pay an income tax of 25 % (reduced to 15 % u n t i l 1976 by the Income Tax A p p l i c a t i o n Rules). This tax i s withheld, under Part XIII I.T.A., by the payer corporation resident i n Canada. I f through the p a r t i c i p a t i o n of Canadian residents the corporation readies the l e g a l l y defined degree of Canadian ownership, the withholding tax w i l l be only 20 % ( i . e . 10 % u n t i l 1976) of the dividend amount. The d i f f e r e n t payments and appropriations deemed to be dividends [see s.15 and s.56(2)1.T.A.] are subject to the with- holding tax by v i r t u e of s.214(3)I.T.A.. Under the o l d Act there was not any p r a c t i c a l d i f f e r e n c e between a company incorporated i n Canada and a company incorporated elsewhere but having i t s common law residence i n Canada because of the l o c a t i o n of i t s c e n t r a l management and c o n t r o l . What was relevant was the residence i n Canada. A l l corporations i n such a s i t u a t i o n were equally treated, the t o t a l tax burden being constituted by the normal corporate tax plus the withholding tax retained on dividends d i s t r i b u t e d by them. Since the enforcement of the new B i l l i ncorporation i n Canada w i l l probably be advantageous, except where a company which has been created i n some other country already had residence i n Canada on the Budget Day (June 18) 1971. In any other case, i n f a c t , the company w i l l not be a Canadian corporation as defined i n s.89(1)(a)I.T.A.. Therefore i t w i l l have to pay 47 the a d d i t i o n a l tax of Part XIV I.T.A.. Whereas the branch earnings tax of s.llOB old Act was l e v i e d only upon non-resident companies the new B i l l makes any corporation, other than a continuous Canadian corporation, l i a b l e f o r i t . The company being resident i n Canada, the non-resident shareholders w i l l also s u f f e r the withholding tax of Part XIII. The new l e g i s l a t i o n , however, provides some r e l i e f i n order to reduce the a d d i t i o n a l tax burden when the resident company pays out dividends. But as the tax on a f t e r - t a x b e n e f i t s may not be completely n e u t r a l i z e d , i t might be better f o r a company incorporated outside Canada to keep i t s residence i n another country and simply to do business i n Canada. Then i t would be l i a b l e for the a d d i t i o n a l tax, but no withholding tax would be retained on dividends flowing down to shareholders. Another argument i n favour of incorporation i n Canada i s that,where i n d i v i d u a l shareholders resident i n Canada p a r t i c i p a t e i n the company, they are e n t i t l e d to the dividend tax c r e d i t of s.121 only when the debtor corporation i s a Canadian corporation. According to s.121 I.T.A., the dividend tax c r e d i t c o n s i s t s of 4/5 of the gross-up prescribed i n s.82(l)(b) which applies only to taxable Canadian corporations, which i s to say, Canadian corporations not exempted — s . 8 9 ( 1 ) ( j ) I . T . A . — . So i f the company i s only resident without being Canadian, the Canadian shareholders would not include any gross-up i n t h e i r income but would be denied any c r e d i t to be claimed against t h e i r tax amount. In other words.Canadians w i l l be discouraged from p a r t i c i p a t i n g i n companies incorporated outside Canada, even i f they acquire resident status i n 48 Canada. If he i s w i l l i n g to be effectively a minority shareholder, the non-resi- dent may, by agreeing to substantial participation of resident i n d i v i - duals or private corporations in that company [s.89(1)(f)I.T.A.], be shareholder of a company incorporated in Canada and benefiting by the new small business incentive —s.125—. Roughly speaking, the small business deduction affects the f i r s t $ 50,000 of net income from Ca- nadian active business, reducing the tax related to this amount to 25 %. This tax incentive only applies to Canadian-controlled private corporations. S.125(6)(a) defines such corporations as being private corporations — s . 8 9 ( l ) ( f ) — which are Canadian corporations —s.89 ( l ) ( a ) — and which are not controlled, directly or indirectly in any manner whatever, by one or more non-resident persons or one or more public corporations [s.89(1)(g)I.T.A.]. The term "controlled corporation" is not explained in regard to this matter, but by analogy with the constant definitions of corporations controlled by other corporations [s.112(6) (b); s.186(2), s.192(4): s.194(3)I.T.A.] i t may be thought that a shareholder controls a corporation when he owns,—either himself or through persons with whom he does not deal at arm's length—, over 50 % of i t s issued share capital (having f u l l voting rights under a l l circumstances). Thus, the non-resident shareholder must have a shareholding lower than 50 X and must not enter into any agreement with other shareholders enabling him to determine their conduct inside the company. Moreover, i f the non-resident takes over the control of the company which, as a result, becomes a non-Canadian-controlled corporation while remaining 49 private.it must remit the Part VI Tax (s.190 I.T.A.) which approximately corresponds to the previously obtained small business tax reduction. B. Companies (i) Branch Non-resident companies can do business in Canada directly or through an agent. As in the case of individuals, the use of an agent makes no difference for tax purposes. In both situations companies have, as commonly said (in a somewhat misleading and imprecise expression), a "branch o f f i c e " in Canada. Such companies are neither private —s.89 ( 1 ) ( f ) — nor public corporations [s.89(l)(g)I.T.A.] as they do not reside i n Canada. According to s.2(3) and s.115(1)I.T.A. they pay corporate income tax at the same rate as any corporation (s.123 and s.124) without any particular advantage. As they do not have their residence i n Canada(and so cannot be Canadian corporations) they also suffer the 25 % (reduced to 15 % u n t i l 1976) additional tax of Part XIV I.T.A. levied on the after-tax profits, without of course any r e l i e f for distribution of dividends (this r e l i e f being only for resident non-Canadian corporations). This tax, a "branch earning tax", already existed by virtue of s.llOB-61d Act. The ownership by non-resident companies of shares of Canadian or resident corporations may raise some questions. If companies own shares without 50 any connection with the business they run i n Canada, the dividends from such shares are probably not included i n t h e i r income. So the withholding tax of Part XIII i s normally l e v i e d , a p r o v i s i o n l i k e s.805 ol d Regulations being expected (see page 45). I f , on the contrary, the shareholding i s i n r e l a t i o n to the branch operations then such dividends are computed as a part of the companies' income. It i s submitted that the new B i l l shows at t h i s point a major d i f f e r e n c e with the old system, a d i f f e r e n c e which, s u r p r i s i n g l y enough, has not been mentioned i n any commentary. It i s p r i m a r i l y that such intercorporate dividends are no longer tax-free when received by a non-resident cor- poration doing business i n Canada. Whereas s . 2 8 ( l ) o l d Act concerned any company paying Part I tax, even i f i t was not resident (as long as s.805 Regulations was complied with),the new p r o v i s i o n [s.112(1) I.T.A.] on tax-free intercorporate dividends only a p p l i e s to resident corporations. As the marginal note r e f e r s to "dividends'received by corporation r e s i d e n t . . . " i t seems to be c l e a r that such r u l e i s intended only f o r r e c i p i e n t corporations r e s i d i n g i n Canada. Thus i t w i l l now be b e t t e r f o r non-resident companies car r y i n g on business i n Canada to have the dividends they receive caught under Part XIII(25 % with- holding tax on gross amount) rather than under Part I through s.2(3) (50 % of the net amount). Canadian i n d i v i d u a l s who are shareholders of such f o r e i g n corporations are not personally a f f e c t e d by the companies' business i n Canada. They w i l l simply include the dividends i n t h e i r income and they w i l l n either 51 add any gross-up ( s.82(l) only applies when dividends are paid by Canadian corporations) nor be e n t i t l e d to deduct any dividend tax c r e d i t ( c f . s.121 I.T.A.) from t h e i r own tax amount. This i s again a d i f f e r e n c e from the old system, which allowed [s.38 (2)old Act] resident i n d i v i d u a l s to claim c r e d i t f o r dividends they received from c e r t a i n non-resident companies doing business i n Canada, and which so offered an incentive f o r a c q u i s i t i o n of shares i n f o r e i g n c o n t r o l l e d companies operating i n Canada^-*. For Canadian resident corporate shareholders(other than p r i v a t e corpora- tions —s.186 I.T . A v r-)of such non-resident companies i t w i l l be more d i f f i c u l t than under the o l d l e g i s l a t i o n to receive t h i s kind of i n t e r - corporate dividend p a r t l y t ax-free. The amount of dividend free of tax has to be, as before, apportioned to the taxable income that the paying corporation earned i n Canada i n the year preceding the taxation year [s.112(2)1.T.A. ; s.28(10)old A c t ] . But the new B i l l also requires that the Canadian income be earned through a Canadian permanent establishment of the non-resident corporation . Carrying on business no longer s u f f i c e s . The Act does not give any d e f i n i t i o n of permanent establishment and s.H2(2) a n t i c i p a t e s that i t w i l l be defined i n the new Regulations. It i s i n t e r e s t i n g to note that i t i s the f i r s t time that t h i s concept appears i n the f e d e r a l 7* Income Tax Act. U n t i l now i t was employed only i n the Regulations 74a (for i n t e r p r o v i n c i a l purposes), i n some p r o v i n c i a l statute and, mainly,in tax t r e a t i e s . Therefore i t may be thought that the d e f i n i t i o n w i l l be s i m i l a r to those of tax conventions The advantages of the "Canadian Branch" s o l u t i o n are that no new incorpo- r a t i o n expenses are incurred and, e s p e c i a l l y , that the branch's l o s s e s , being deductible f o r the non-resident (main) company, can be absorbed more e a s i l y , so making the branch p a r t i c u l a r l y a t t r a c t i v e for speculative ventures i n Canada7"*. Probably the a d d i t i o n a l tax (Part XIV) i s e a s i e r to avoid than the withholding tax on dividends d i s t r i b u t e d by a resident subsidiary The disadvantages r e s u l t from the d i f f i c u l t y of determining the p r o f i t s a l l o c a b l e to the branch and from the differences' between the Canadian income computation method and sources q u a l i f i c a t i o n , and the f o r e i g n methods and q u a l i f i c a t i o n s . Moreover, p r o v i n c i a l l i c e n s e s w i l l be necessa- ry to do business i n Canada. ( i i ) Subsidiary Non-resident companies can incorporate s u b s i d i a r i e s resident i n Canada to carry on business i n t h i s country. The s u b s i d i a r i e s pay the ordinary corporate income tax, and the non-resident parent companies then remit the 25 % ( r e s p e c t i v e l y 15 % u n t i l 1976) withholding tax on dividends, t h i s l a s t rate being reduced by 5 % i n the case of s u b s i d i a r i e s having a degree of Canadian ownership. To escape the Part XIV a d d i t i o n a l tax, s u b s i d i a r i e s have to be incorpo- rated i n Canada unless they were resident on June 18, 1971 because 53 q u a l i f i c a t i o n as Canadian corporation i s required. When resid e n t , but non-Canadian, corporations pay out dividends (subject to the withholding tax i n the case of for e i g n parents' s u b s i d i a r i e s ) a p a r t i a l r e l i e f i s provided by the Act. The observations made about the p a r t i c i p a t i o n of non-resident i n d i v i d u a l s i n Canadian-controlled p r i v a t e corporations [s.125(6)(a)I.T.A.] are v a l i d here f o r s u b s i d i a r i e s incorporated i n Canada. The q u a l i f i c a t i o n of the subsidiary as a Canadian corporation i s necessary i n order that i n d i v i d u a l shareholders r e s i d i n g i n Canada may b e n e f i t from the dividend tax c r e d i t [s.82(l)(b) and s.121 I.T.A.]. It would be denied them i n the event that the company incorporated elsewhere has acquired common law residence a f t e r the Budget Day 1971. Again, that q u a l i f i c a t i o n i s required i n order to have dividends flowing tax-free to corporate shareholders resident i n Canada [s.112(1)(a) I.T.A.]. The residence i n Canada of the su b s i d i a r y i s not s u f f i c i e n t except where there i s c o n t r o l ( i . e . over 50 % of the voting shares) — s . H 2 ( l ) (b) — . Even i f a l l provisions based on the concept of Canadian corporation have been enacted f o r the purpose of discouraging incorporation outside Canada, the a p p l i c a t i o n of the p r i n c i p l e i n s.112(1)1.T.A. leads to an apparently contradictory and overly severe tax treatment. In f a c t resident corporate shareholders may receive dividends at l e a s t p a r t l y tax-free from non-resident companies having a permanent establishment 54 i n Canada — s . H 2 ( 2 ) — , but they are not e n t i t l e d to any tax r e l i e f f o r dividends paid to them by resident companies which do not q u a l i f y as Canadian corporations. A f t e r d i s t r i b u t i o n to t h e i r own shareholders such earnings w i l l have been taxed three times. If the Canadian s u b s i d i a r y i s established f o r the purpose of purchasing a company r e s i d i n g i n Canada, problems a r i s e as to losses and designated surpluses. Any los s connected with any p a r t i c u l a r business cannot be c a r r i e d forward where persons (corporations e.g.) which were not c a r r y i n g on that business acquire the c o n t r o l of the company : s.111(5)1.T.A. [s.27(5)and (5a) o l d A c t ] . The same r u l e applies now to c a p i t a l losses [s.111(4)1.T.A.]. Dividends out of designated surpluses flowing to non-resident c o n t r o l l i n g corporate shareholders are subject to the 15 % Part VIII tax to be suffer e d by the payor corporation : s.194(1)I.T.A. [s.105 B ( l ) ( a ) o l d A c t ] . The normal withholding tax w i l l a l s o be retained, f o r such dividends are taxable dividends (see s.192(1)1.T.A.). Under the old system there was some tax incentive f o r the sale of a Canadian company, which had an important undistributed income, to a non - resident corporation rather than to another Canadian one, as the t o t a l burden i n the f i r s t event was only 30 % (instead of 50 % ) 7 7 That w i l l now be ended,for, although the tax paid by residents on dividends out of designated surpluses — P a r t VII t a x — i s 25 % [s. 192(1) I.T.A. ], such tax c o n s t i t u t e s the t o t a l tax, these dividends being now deductible when computing the taxable income of the r e c i p i e n t . In fact s.112 I.T.A. does not provide any p r o h i b i t i o n s i m i l a r to s.28(2) old Act. For the 55 non-resident the t o t a l tax w i l l be 40 % (or 30 % u n t i l 1976). If the subsidiary i s incorporated outside Canada a f t e r June 18,71 then i t i s better that i t keeps i t s residence i n another country so that no withholding tax w i l l be paid on i t s dividends. The subsidiary w i l l remit the a d d i t i o n a l tax which even i n the case of residence i n Canada i s not completely avoidable. 73 It has been suggested that the s o l u t i o n of the non-resident s u b s i d i a r y only doing business i n Canada may become a t t r a c t i v e f o r the d i s t r i b u t i o n of accumulated income, when the company discontinues the business and then winds up. S.81(7)old Act excluded the a p p l i c a t i o n of s.81 when more than 50 % of the shares belonged to non-residents. That appears s t i l l to be true under the new law, f o r s.84(2)1.T.A., which creates deemed dividends when funds or properties of a company are d i s t r i b u t e d upon winding up, only concerns resident companies. The advantages of the subsidiary ( q u a l i f y i n g as Canadian corporation) are f a c i l i t y i n accounting and i n f i n a n c i a l c o n t r o l , e a s i e r compliance with Canadian regulations as the accounts are separate, no necessity for l i c e n c e s and a bet t e r ( p o l i t i c a l ) p o s i t i o n i n Canada (for excise 79 and customs duties and f o r incentives . The disadvantages are a p p l i c a t i o n of the withholding tax on dividends to non-residents, i n c o r p o r a t i o n fees and i m p o s s i b i l i t y f o r the parent company to absorb the subsidiary's l o s s e s . 56 3. ADDITIONAL BRANCH TAX Part XIV I.T.A. provides that corporations, other than Canadian corpo- rations, pay an additional tax on their after-tax profits when they carry on business in Canada. This tax, commonly called "branch o f f i c e " tax, existed in the old legislation. The new B i l l , however, introduces some changes extending the application of this tax and rendering i t s calculation more complicated. Under the old system this tax (Part III A) concerned only non-resident companies carrying on business in Canada and their income earned through such businessfs.110 B (l)old Act]. The tax basis was obtained by deducting from the taxable income earned i n Canada [ss(a)] the (federal) Part I income tax, the provincial income taxes (for the part not deductible under Part I in computing the income) and an allowance for net increases in their capital investment in property in Canada [ss(b)]. The tax rate was 15 %. The allowance was, according to s.808 Regulations, the difference between the taxpayer's capital investment in property(undepreciated capital cost of depreciable property and cost of land less unpaid portions of purchase price and amounts borrowed for the purpose) at the end of the taxation year and the sum of the allowances for previous years after 1960 plus the Canadian capital investment when starting to suffer the branch tax. The additional tax was not applied to some kinds of companies, li s t e d in s.110 B (2), and was substituted for by two special additional taxes 57 f o r non-resident insurers [s.llOB(4) and (5)old A c t ] . U n t i l 1961 the 15 % branch tax did not e x i s t , so non-resident corpo- rations doing business i n Canada d i r e c t l y were i n a better p o s i t i o n than were non-resident companies which had incorporated a subsidiary r e s i d i n g i n the country. The a d d i t i o n a l tax was, therefore, intended to avoid d i f f e r e n c i e s of tax treatment between branches and Canadian s u b s i d i a r i e s and was l e v i e d on the a f t e r - t a x earnings a v a i l a b l e f o r transfer to the main company. The branch tax has been considered as a 80 tax on the current undistributed p r o f i t s . In the new l e g i s l a t i o n the Part XIV a d d i t i o n a l tax applies to any company carry i n g on business i n Canada and which i s not a Canadian corporation [s.219(1)1.T.A.]. As the Canadian corporation i s defined as a company which was e i t h e r incorporated i n Canada or continuously resident i n Canada since June 18, 1971 [s.89(1)(a)] i t follows, as already mentioned, that a company created i n another country and which acquired common law residence a f t e r that date w i l l now be taxed despite i t s residence i n Canada. Since f o r resident companies which d i s t r i b u t e (taxable) dividends (subject to the withholding tax when paid to non-residents) the tax burden would become too heavy, s . 2 1 9 ( l ) ( i ) o f f e r s some r e l i e f . The tax rate i s 25 % [s.219(1)I.T.A.] but i t i s reduced by the A p p l i c a t i o n Rule 11 (1) to 15 % u n t i l the end of 1975. As there are some d i f f e r e n c i e s i n e s t a b l i s h i n g the tax basis f o r resident and non-resident companies, i t seems wise to deal separately with them. 58 a) Non-resident corporations The basis f o r the a d d i t i o n a l tax w i l l be : the year's corporation's taxable income — s . 2 1 9 ( 1 ) ( a ) — plus the allowance f o r investment i n property i n Canada which was claimed i n the preceding year — 2 1 9 ( 1 ) ( b ) — minus the aggregate of : - net taxable c a p i t a l gains on taxable Canadian property or net taxable c a p i t a l gains on taxable Canadian property other than Canadian business property, whichever i s the l e s s — 2 1 9 ( 1 ) ( d ) — - f e d e r a l Part I tax l e s s the proportion of t h i s tax a t t r i b u t a b l e to the above c a p i t a l gains — 2 1 9 ( l ) ( e ) — - p r o v i n c i a l income taxes, to the extent that they were not deductible i n computing the income, les s the proportion of these taxes a t t r i b u t a b l e to the above c a p i t a l gains — 2 1 9 ( 1 ) ( f ) — - prescribed allowances f o r investment i n property i n Canada — 2 1 9 ( 1 ) ( h ) — b) Resident corporations In t h i s case the basis f o r the a d d i t i o n a l tax w i l l be : the corporation's taxable income f o r the year — 2 1 9 ( 1 ) ( a ) — plus the allowance f o r investment i n property i n Canada claimed i n the preceding year — 2 1 9 ( 1 ) ( b ) — plus the dividends deduction claimed i n the preceding year — 2 1 9 ( 1 ) ( c ) — minus the aggregate of: - f e d e r a l Part I (income) tax —219(1) (e) — - p r o v i n c i a l income taxes, as long as not deductible i n computing the income —219(1) (f) — 59 - foreign tax credit deduct under s.126 I.T.A. from the tax plus 1/2 of the corporation's tax income or of the foreign income and taxable capital gains, whichever i s the less — 2 1 9 ( l ) ( g ) — - prescribed allowance for investment in property in Canada —219(1)(h)— - dividends paid less 1/2 of the foreign income and taxable capital gains. The result of these somewhat complicated computations i s that i n both situations the additional tax w i l l be levied on after-tax Canadian source Income^ The government has anticipated that the allowance for increase i n Canadian assets w i l l be extended to working capital and 82 w i l l be subject to recapture i f investment i s reduced . The new Regu- lations w i l l probably provide no deduction of previous years' allowance, unlike old Regulations 808(1)(a), in calculating the allowance —219 ( l ) ( h ) — , as such allowances of the preceding years w i l l now be included i n the income (for additional tax purposes) every year [s.219(1)(b)I.T.A.]. The jurisprudence on this matter i s very limited. In Union O i l Co. 83 of California v. M.N.R. i t was decided that a corporation which had compensated i t s income tax with certain tax credits could make no deduction under s.llOB(b)old Act from i t s taxable income of tax payable. The taxable income, therefore,,was entirely subject to the additional tax. In a case, then affirmed by the Supreme Court, the Exchequer Court held that a non-resident was entitled when computing the income of i t s Canadian branch to deduct the portion of the foreign head office's administration costs attributable to the Canadian operations(Furness Withy & Co* Ltd. v. M.N.R.)84 60 Some corporations are exempted from the a d d i t i o n a l tax : banks, transpor- t a t i o n and communications, mining i r o n ore i n Canada, organizations exempted from any income tax under s.149 (non-profit, c h a r i t y , housing, s c i e n t i f i c research)[s.219(2)I.T.A.]. The only change i s the exclusion of c e r t a i n o l d companies exempted by v i r t u e of s.llOB(2)old Act. Non-resident insurers do not pay, as they did under the o l d l e g i s l a t i o n , the branch tax of s.219(1). However when they e l e c t to compute t h e i r Canadian investment fund i n order to deduct the di f f e r e n c e between t h i s fund and c e r t a i n l i a b i l i t i e s incurred i n the course of t h e i r Canadian operations, they then must pay an a d d i t i o n a l tax of 25 % of that de- duction — 2 1 9 ( 4 ) I . T . A . — . Secondly they also s u f f e r a s p e c i a l tax of 25 % of the d i f f e r e n c e between t h e i r Canadian investment fund and the value of t h e i r Canadian assets. S . l l ( l ) A p p l i c a t i o n Rules reduces both rates to 15 % from 1972 to the end 1975. 61 IV. INVESTMENT INCOME EARNED FROM CANADA BY NON - RESIDENTS 1. IN GENERAL Non-residents receiving payments from Canada are subject on such amounts to a special tax provided by Part XIII of the Income Tax Act. The person who owes the tax (the taxpayer) is the non-resident payee, but as the tax is to be withheld by the resident payor and remitted by him on behalf of the non-resident person the tax is generally called with- holding tax. According to the Act the tax i s levied only on itemized types of revenue flowing to non-residents, but the l i s t is so complete and the terms are so broad that practically no kind of revenue from investments which non-residents make in Canada escapes the withholding tax. In the Act the tax is designated as an income tax although i t i s quite different from the ordinary Part I income tax. In fact for the purposes of Part I income tax the taxpayer has to find out his net income by deducting his expenses from the gross income. Then he must compute his taxable income by making the allowable deductions and personal exemptions. In the case of payments to non-residents subject to the withholding 85 tax, however, s.214(1)1.T.A. prohibits any deduction so that the tax i s levied on the gross amount of the payment. Probably the reason why i t i s designated as income tax i s that a l l payments imposed under 85a this part of the legislation are of an income nature . When non-residents 62 whose investment incomes are taxable within Part XIII I.T.A. r e a l i z e c a p i t a l gain on the d i s p o s i t i o n of taxable Canadian property (perhaps the investment asset i t s e l f ) then they become non-residents taxable on such gain under Part I by v i r t u e of s.2(3)(c)I.T.A.. The tax i s due not only when the non-resident taxpayer receives the amount paid to him but when the payment i s made. S.212(1) reads that the tax s h a l l be paid when the resident debtor pays or c r e d i t s , or i s deemed by Part I to pay or c r e d i t , to the non-resident c r e d i t o r an amount on account or i n l i e u of payment of, or i n s a t i s f a c t i o n of one of the various l i s t e d items of income. When the non-resident c r e d i t o r receives i n l i e u of payment a s e c u r i t y or other r i g h t , a c e r t i f i c a t e or other evidence of indebtedness, the value of the s e c u r i t y s h a l l be deemed to have been paid to him i n r e l a t i o n to the debt i n respect of which he received i t [s.214(4) and s.76(1)1.T.A.]. The withholding tax i s l e v i e d on the gross amounts regardless of the taxpayer's h a b i l i t y to pay. The tax rate of 25 % —s.212(1) and ( 2 ) — i s generally the same f o r everybody and f o r every kind of payment. U n t i l the end of 1975, however, the rate w i l l remain at 15 % [s.10 (2) (a) Income Tax A p p l i c a t i o n Rules] as i t was under the old system. The period ending i n 1976 i s also the period ind i c a t e d by the government fo r renegotiation of e x i s t i n g tax t r e a t i e s and entering into new conventions with other countries. In the case of dividends d i s t r i b u t e d by corporations having a degree 63 of Canadian ownership the withholding tax w i l l be only 20 %, but,once again, 10 % u n t i l the end of 1975. The tax is imposed on payments made to non-residents. The question of residence (or of non-residence) is answered by the c r i t e r i a presented in chapter II above. It is notable that s.214(13) empowers the Governor in Council to make general or special regulations prescribing who is or has been resident in Canada. Where non-residents carry on business in Canada investment income continues to be caught under Part XIII, except for those amounts which may reasonably be attributed to the business carried on in Canada, i f a provision such as s.805 old Regulations is enacted. This may be expected because of s.214(13)(c)I.T.A. which allows the establishment of regulations in this regard. Collection of tax Part XIII income tax i s , as noted above, a withholding tax. The system was the same under the old Act. The resident payor shall withhold or deduct from the payment he makes to the non-resident the appropriate amount of tax and immediately remit i t to the Receiver General on behalf of the non-resident taxpayer[s.215 (l)I.T.A.]. Where the Canadian debtor acts through an agent paying the non-resident on his behalf, particularly in the case of redemption of bearer coupons or warrants, s.215(2) imposes the obligation of withholding upon the agent. Where the payment is made to an agent of the 64 non-resident c r e d i t o r without the tax having been retained, the non - resident's agent s h a l l himself withhold the tax — 2 1 5 ( 3 ) - - . The o b l i g a t i o n for the resident debtor to withhold and remit the tax e x i s t s notwithstanding any agreement or any law providing the contrary [s.215(1)I. T.A. ]. The non-resident cannot complain and he i s not e n t i t l e d to sue the payor who has deducted the tax amount : s.227(1). Where the debtor has not r e g u l a r l y or has not at a l l withheld the amounts of tax he ought to have retained,the debtor i s l i a b l e to pay as Part XIII tax the whole of such amounts and he i s allowed to deduct them from any payment to the non-resident [s.215(6)I.T.A.]. The r e s p o n s i b i l i t y of the resident payor i s very heavy ; i f he does not withhold the tax he i s l i a b l e to pay i t s t o t a l i t y plus an i n t e r e s t at a prescribed rate per annum [s.227(8)I.T.A.]. Under the o l d Act — s . 1 2 3 ( 8 ) — the i n t e r e s t rate was 10 % ; i t w i l l now be f i x e d i n the Regulations. A penalty i s a l s o provided for a resident who withholds the tax but f a i l s to remit i t : 227(9)1.T.A.. S.215(4)I.T.A. reads that Regulations may be enacted i n order to except the a p p l i c a t i o n of the withholding r u l e f o r payments made to non-residents carrying on business i n Canada. These would have to f i l e a s p e c i a l return and then pay Part XIII tax themselves. I t i s important to notice that t h e i r investment income would then continue to be caught under Part XIII. The opportunity perhaps afforded by s.215(4) i s not to be confused with the p o s s i b i l i t y (s.214(13)(c) and Regulations) of having part of such investment income included i n the business income earned 65 in Canada. S.215(4)1.T.A. in fact deals only with the deduction of the tax amounts and refers to the payment of the tax ''imposed by this (XIII) Part". 2. INTEREST Interest payments made by residents to non-residents constitute a f a i r l y simple class of investment income subject to the withholding tax: s.212 (D(b)I.T.A. [s.106(1) (b)old Act]. Any interest except that specifically exempted i s liable to this tax. Where a payment i s partly capital and partly interest that part which can reasonably regarded as interest is submitted to tax : s.214(2) simply extends the bear of s.16(1)I.T.A. The B i l l extends the withholding tax to two other kinds of interest: accrued bond interest and discount on sale of obligations. The old Act contained in i t s Part I some provisions [s.7(2) and 19A] to which.however, no reference was made under Part III (withholding tax). Although the law 86 was not very clear,accrued interest was probably not considered as income and non-residents could easily avoid the withholding tax by se l l i n g securities to residents prior to maturity at a price which included the accrued interest. The new rule about Part XIII tax on accrued interest and discount apply to short-term securities (bonds.debentures.bills, notes, mortgages, hypothecs or similar obligations) issued after Junel8,1971. Withholding tax is levied on accrued interest when a non-resident (transfe- 66 ror) t r a n s f e r s to a resident (transferee) an obligation,whose i n t e r e s t i s not due yet and a part of which would be, i f s.20(14) were a p p l i c a b l e , included i n the transferor's income. According to s.214(6) such an amount i s deemed to be an i n t e r e s t payment by the transferee to the non-resident transferor and i t i s , therefore, l i a b l e to the withholding tax, provided that the tra n s f e r r e d debt i s : neither a government bond, other p u b l i c o b l i g a t i o n or debt whose i n t e r e s t i s payable i n for e i g n currency ; nor an o b l i g a t i o n whose i s s u e r has l e s s than f i v e years to reimburse more than 25 % of the borrowed sum ; nor a p u b l i c issue s e c u r i t y [214 ( 8 ) ( a ) ( i ) to ( i i i ) I . T . A ] . I f the resident acquiring the o b l i g a t i o n (transferee) i s a non-resident-owned investment corporation, the normal exemption of s.212(1)(b)(i) does not apply and the tax must be paid. The rule imposing the accrued i n t e r e s t i s also applicable when the transferee i s a non-resident c a r r y i n g on business i n Canada and e n t i t l e d to the corresponding deduction of s.20(14)(b) [s.214(9)1.T.A.]. When a resident issues or s e l l s to a non-resident an o b l i g a t i o n at discount, i . e . f o r a p r i c e l e s s than the p r i n c i p a l amount, then 4/3 of the discount i s deemed to be an i n t e r e s t payment to the non-resident at the time of the transaction and i t s u f f e r s withholding tax [s.214 (7)I.T.A.]. U n t i l the end of 1975 the deemed i n t e r e s t w i l l be 100/85 (instead of 4/3) of the discount amount, as prescribed by s.l0(2)(b) A p p l i c a t i o n Rules. The withholding tax on discount i s escaped by "excluded o b l i g a t i o n s , which are o b l i g a t i o n s whose accrued i n t e r e s t i s not taxed [s.214(8)(a)(i) to ( i i i ) ] , and ob l i g a t i o n s whose o r i g i n a l issue discount i s not greater than 3 % and whose a c t u a l annual y i e l d does not exceed 4/3 of the stated i n t e r e s t rate [s.214(8) (a)I.T.A.]. 67 Again, should the issuer or s e l l e r be a non-resident-owned investment corporation the ordinary exemption does not apply — s . 2 1 4 ( 1 1 ) — . I f the non-resident who subscribed or acquired the debt s e l l s , i t before maturity to a resident, he then i s e n t i t l e d to a proportional refund [s.214(7) and 227(6)]. At th i s moment, however, he w i l l pay the tax on the accrued i n t e r e s t by v i r t u e of s.214(6)I.T.A.. The p r e s c r i p t i o n taxing the discount a l s o applies where the person i s s u i n g or s e l l i n g the o b l i g a t i o n i s a non-resident doing business i n Canada [214(10) I.T.A.]. F i n a l l y the ru l e concerning combined c a p i t a l and income payments i s not applicable i n respect of discount obligations[214(12) I.T.A.] ; otherwise there would be a danger of double taxation. I t i s notable that these provisions regarding accrued bond i n t e r e s t and discount o b l i g a t i o n have been made applicable by s.76(2)Applications Rules from June 19,1971 s.76(1)Rules having amended the old Act by adding to i t the new s.l08(4a) to (4g). The withholding tax rate of 25 % [212(1)(a)I.T.A.] i s reduced to 15 % u n t i l end 1975 through s.10(2)(a)Rules. A f t e r 1976 the rate w i l l be maintained at 15 % i n favour of non-residents, l i v i n g i n countries probably to be prescribed by Regulations, i f the obli g a t i o n s have been issued before 1976 and the residents paying the i n t e r e s t have dealt with them at arm's length : s.l0(4)Rules. A s p e c i a l rate of 5 % i s provided by s.212(6)1.T.A. (whose misleading marginal note has not been corrected) f o r i n t e r e s t from p r o v i n c i a l bonds issued before December 20,1960 — 2 1 2 ( 7 ) — or a f t e r that date but i n exchange of bonds which had been themselves issued before [s.212(3)]. 68 Exempted Interest As in the old legislation, the new B i l l exempts a certain number of interest payments from the withholding tax ; changes are not numerous and introduce only minor restrictions. Interests payable by non-resident-owned investment corporations continue to be tax-free [s.212(1)(b)(i)I.T.A.]. These interests are not deductible as expenses when computing the income of such companies. The fact that the withholding tax exemption of interest payments made by such corporations has not been affected by the legislative revision i s to be underlined, for the whole treatment of non-resident-owned investment corporations has been modified. In particular, their dividends flowing to non-residents are no longer tax-free. Another class of exempt payments comprises interest from bonds issued before December 20,1960 or guaranteed by the Canadian government ; similar bonds, issued before April 16,1966, whose yield i s paid to the governments or central banks of foreign countries or to international organizations l i s t e d in s.806 old Regulations; obligations of the federal government, of provincial governments, of municipalities, of local organizations with a 90 % financial Crown participation; of educational institutions or hospitals when they are supported in such transactions by a provincial government. The time condition for such securities i s issuance after April 15,1966 and, as newly enacted, before 1976 [s.212(l)(b)(ii)(A) to (C)I.T.A.]. 69 The law exempts interest payable in a foreign currency on the following: obligations issued or stipulated in writing before December 20,1960; debts owed by banks subject to the Bank Act; and indebtedness entered into in the course of carrying on business in a foreign country, provided (this being added by the new B i l l ) that the Canadian taxpayer i s allowed to deduct the payment i n computing his income [s.212(1)(b)(iii)(A) to(F)I.T.A.]. An essential condition for exemption i s that the resident debtor and the non-resident creditor deal at arm's length. The facts indicating that the parties to the transaction are not dealing at arm's length have to be clearly ascertainable because the presumption of non-arm's length, even when j u s t i f i e d by the situation, is a rebuttable one^§ 89 In a recent case Swiss Bank Co. and Swiss Credit Bank v. M.N.R. both banks controlled a company which was the manager of an investment fund that owned a l l shares of a Canadian corporation. The banks lent to the Canadian corporation money raised for the fund and they contended that the interest on the loan paid to them in Swiss francs was exempt from withholding tax. The Exchequer Court held that the recipients and the debtor were not dealing at arm's length, the bank and the management company acting in concert and having a l l voting power inside the Canadian corporation, to which they could dictate what to do and so could exert their influence. Finally, the interest is to be effectively paid in a foreign currency and not simply stipulated payable. Thus i t was decided that the debentureholders of a resident company, whose securities' interest was payable in U.S. $ and which paid i t for a certain time by issuing 70 common shares to them, were denied the statutory exemption(Hanitour 90 Beaune Mines Ltd. v. M.N.R.) . The l a s t group of exempt i n t e r e s t s i s that of payments made on o b l i g a t i o n s issued a f t e r June 13,1963 to persons holding a c e r t i f i c a t e of exemption: s.212(1)(b)(iv). As under the o l d system, such a c e r t i f i c a t e i s issued, upon a p p l i c a t i o n to the M i n i s t e r , to persons who reside i n a country imposing an income tax and who are tax-exempt i n that country. S.212 (14)1.T.A. enacts a severe supplementary r e s t r i c t i o n : the c e r t i f i c a t e i s granted only to persons who e i t h e r would be tax-exempt w i t h i n s.149, i f they were resident i n Canada, or are t r u s t s or corporations created s o l e l y f o r employees' superannuation or pension funds or plans. The r e s t r i c t i v e new q u a l i f i c a t i o n w i l l lead to the exclusion of c e r t a i n non-resident e n t i t i e s , e. g. f o r e i g n holding corporations of j u r i s d i c t i o n s such as Luxembourg, which formely benefited . by the exemption^ Some concern had been expressed about the f a c t that the government had not c e r t i f i e d what would happen with the e x i s t i n g c e r t i f i c a t e s whose v a l i d i t y QJ l a s t s over 1971 and whose holders do not meet the new requirements . When the new B i l l was amended a p r e s c r i p t i o n was incorporated i n the Ap p l i c a t i o n Rules — S . 1 0 ( 5 ) — providing that the exemption c e r t i f i c a t e s issued under the o l d Act are deemed to be i n force u n t i l end 1974, except that i f the bearer has ceased to be an exempt person ( i n h i s own country) before that time, the c e r t i f i c a t e ceases to be i n force e i t h e r on January 1,1972 or on the day of the end of the exemption, whichever i s l a t e r . 71 Loans to whollly-Owned Subsidiaries S.110 A old Act r e c i t e d that under c e r t a i n circumstances the i n t e r e s t paid on loans granted by non-resident companies to Canadian s u b s i d i a r i e s may be exempted from the withholding tax; this has been reprinted i n s.218 I.T.A.. The Act deals with non-resident parent corporations, which are indebted to a Canadian resident or to a non-resident insurance company doing business i n Canada ( c r e d i t o r s ) and which must pay i n t e r e s t i n Canadian currency. If these corporations have r e - l e n t the same money at the same rate to t h e i r wholly-owned s u b s i d i a r i e s r e s i d i n g i n Canada, whose p r i n c i p a l business i s the making of loans, then the amounts so l e n t by the parents are deemed to have been borrowed by them as agents of t h e i r s u b s i d i a r i e s and the i n t e r e s t paid by the l a t t e r to the parent is considered to have been paid d i r e c t l y to the c r e d i t o r s . So, no Part XIII tax i s suffered by the non-resident parents : s.218(1). To obtain the b e n e f i t a j o i n t e l e c t i o n has to be f i l e d , within 12 months a f t e r any payment, by the parent company and the c r e d i t o r [s.218(3) and (4) I.T.A.]. The r e l i e f i s extended by s.218(2) to the case i n which the money has been l e n t to a s u b s i d i a r y whose p r i n c i p a l business i s not loaning, and then r e - l e n t by i t to a wholly-owned subsidiary conducting such business. The explanation of these s p e c i a l rules i s that the money 93 paid on account of i n t e r e s t by the s u b s i d i a r y never leaves Canada . 3. DIVIDENDS Dividends d i s t r i b u t e d by resident corporations to non-resident shareholders 72 are subject to the withholding tax by v i r t u e of s.212(2)1.T.A.. Within the p r o v i s i o n come those taxable dividends, other than s p e c i a l c a p i t a l gains dividends, which are defined by s . 8 9 ( l ) ( j ) a s any dividend i n respect of which no e l e c t i o n was made i n accordance with s.83.. The dividends which may be covered by an e l e c t i o n under s.83(l) are those out of the tax-paid u n d i s t r i b u t e d income and 1971 c a p i t a l surplus. As they are not taxable dividends no withholding tax w i l l be imposed. Also caught are c a p i t a l dividends which are dividends d i s t r i b u t e d out of the c a p i t a l dividend account [s.89(l) (b) ] . This account i s roughly 1/2 of the net c a p i t a l gains accumulated and d i s t r i b u t a b l e tax-free by p r i v a t e corporations to t h e i r resident shareholders [s.83(2)]. The withholding tax i s l e v i e d on " e f f e c t i v e " dividends as w e l l as on deemed dividends (s.84: increases of c a p i t a l ; d i s t r i b u t i o n s on winding-up; redemptions; reduction of c a p i t a l ) . The l a t t e r also include —s.214 ( 3 ) — the payments which according to s.I5 are computed i n the income of shareholders and considered to be received by them as dividends 94 (appropriations of the corporations properties to shareholders 7 ; 95 loans made by corporations to shareholders except i n p a r t i c u l a r cases; i n t e r e s t on income bonds; or use of a c a r ) . Also included are payments which according to s.56(2) are i n d i r e c t payments. It i s to be noticed that since the new B i l l has been enforced the term "dividend" includes (s.248) a stock dividend other than one that was paid before 1972, whereas s.139(1)(k)old Act read that stock-dividends 73 were not dividends. In this regard i t i s i n t e r e s t i n g to observe that i n r e l a t i o n to the withholding tax the Exchequer Court had e a r l i e r decided, under the Income War Tax Act, that a stock dividend "was a dividend regardless of the fact that no ''payment" and no 'currency" was a c t u a l l y involved i n a transaction (The King v. Johnson Matthey 96 & Co. Ltd.) " Two kinds of dividends exempted from the withholding tax under s.106 ( l a ) o l d Act w i l l now s u f f e r Part XIII tax. These are dividends formerly paid o f f by personal corporations — b u t the concept of personal corporations has disappeared with the l e g i s l a t i v e r e v i s i o n — and those flowing from non-resident-owned investment corporations. On the other hand, c a p i t a l gains dividends d i s t r i b u t e d by non-resident -owned investment corporations and mutual fund corporations [s.212(2) I.T.A.] are not subject to withholding tax. Dividends which may s t i l l be free of withholding tax are those d i s t r i b u t e d by f o r e i g n business corporations. However,at l e a s t 90 % of the income of such corporations must be earned by operating p u b l i c u t i l i t i e s or by mining, transporting or processing ore i n the same country i n which reside e i t h e r non-resident i n d i v i d u a l shareholders or i n d i v i d u a l s owning more than 50 % of non-resident companies, which companies are themselves shareholders, of the f o r e i g n business c o r p o r a t i o n s . — S.213(1)1.T.A. 96a [s,107(l)old Act] . As the concept of a f o r e i g n business corporation i s going to be phased out within four years (s.60 A p p l i c a t i o n Rules), s.213(3) prescribes that f o r the purpose of exemption a company w i l l be considered a f o r e i g n business corporation i f i t would have been considered 74 such under s.71 of the old Act. The tax rate of 25 % [s.212(2)I.T.A.] w i l l be only 15 % u n t i l the end of 1975 by v i r t u e of s.l0(2)(a) A p p l i c a t i o n Rules. As already mentioned, when the paying corporation has a degree of Canadian ownership the tax rate i s the normal percentage minus 5 % , i n other words 10 % u n t i l the end of 1975 and afterwards 20 %. Degree of Canadian Ownership The s t a t u t o r y d e f i n i t i o n of the "degree of Canadian ownership" enabling the non-resident shareholders of corporations reaching i t to receive dividends taxed at a reduced withholding tax i s contained i n s.257 I.T.A. 97 (s.139 A o l d A c t ) . I t i s extremely complicated . When e s t a b l i s h i n g the main c r i t e r i a of such a d e f i n i t i o n one can say that a company has a degree of Canadian ownership where [s.257(1)I.T.A.] : a) i t i s resident i n Canada; b) i n any year a f t e r 1964 not l e s s than 25 % of the d i r e c t o r s reside i n Canada; c) the corporation i s 1) a corporation i n which not l e s s than 25 % of issued and outstanding shares , having f u l l voting rights, and equity shares representing not l e s s than 25 % of that part of the paid-up c a p i t a l represented by a l l issued and outstandin'g equity shares, belong to i n d i v i d u a l s resident i n Canada or corporations c o n t r o l l e d i n Canada; or 75 2) a corporation, having a cla s s or classes of shares l i s t e d on a prescribed stock exchange i n Canada, and i n which no one non-resident owns more than 75 % of the issued and outstanding shares (having f u l l v o t i n g r i g h t s ) , and more than 75 % of that part of the paid-up c a p i t a l represented by a l l the issued and outstanding equity shares; or 3) a subsidiary c o n t r o l l e d corporation of which equity shares representing at l e a s t 75 % of that part of the paid-up c a p i t a l , represented by a l l the issued and outstanding equity shares, belong to the parent company, to a corporation c o n t r o l l e d i n Canada, or to an i n d i v i d u a l r e s i d i n g i n Canada; or 4) a wholly-owned subsidiary of a corporation as defined under n.l) to 3 ) . The d i f f e r e n t concepts used i n s.257(1) are i n turn defined i n the other subsections of s.257,whose p e c u l i a r d e t a i l s are not to be examined i n t h i s paper. It w i l l only be noticed that s.257(2)(e) defines an equity share as a share other than a non- p a r t i c i p a t i n g share [s.257 ( 2 ) ( f ) ] . According to s.257(2)(a) a corporation i s c o n t r o l l e d i n Canada when i t i s resident i n Canada and when more than 50 % of the shares (shares representing more than 50 % of i t s paid-up c a p i t a l , equity shares representing more than 50 % of that part of the paid-up c a p i t a l represented by a l l the equity shares) belong to i n d i v i d u a l s resident i n Canada or to corporations being themselves c o n t r o l l e d i n Canada. Under the old l e g i s l a t i o n , the q u a l i f i c a t i o n of a company as one having 76 a degree of Canadian ownership e n t i t l e d i t to accelerated c a p i t a l cost allowances — c l a s s l 9 — f or i t s assets [s.1100(1)(n)old Regulations). 4. RENT Although i n the Income Tax Act rents, r o y a l t i e s and s i m i l a r payments are treated as the same type of income f o r the purposes of withholding Part XIII tax, r e n t a l s and r o y a l t i e s w i l l be dealt with separately herein f o r p r a c t i c a l reasons and without presumption of e s t a b l i s h i n g d i s t i n c t i o n s . Rent or s i m i l a r payments which residents make to non-residents for the use of or the r i g h t to use any property i n Canada s u f f e r withholding tax: s.212(1)(d)(i)I.T.A.. This p r o v i s i o n concerns any kind of property which can be used by residents, except railway r o l l i n g stock used by railway companies and corporeal properties used outside Canada [s.212(1)(d)(vii) and ( i x ) I . T . A . ] . The new B i l l provides another exemption covering payments from a resident car r y i n g on business outside Canada i f he deals at arm's length with the non-resident payee. Moreover i n order f o r the non-resident to b e n e f i t from the exemption the resident payor must be able to deduct the amount paid when computing his income [s.212(1)(d)(x)]. The withholding tax may also be l e v i e d on rentals paid to non-residents by other non-residents when the rent i s due f o r property used i n Canada: 77 s.212(13)I.T.A.. The tax rate amounts to 25 % — s . 2 1 2 ( 1 ) — reduced to 15 % u n t i l 1976 [ s . l 0 ( 2 ) ( a ) R u l e s ] . It may be d i f f i c u l t to determine whether a c e r t a i n payment should be considered s i m i l a r to a rent and, therefore,be caught under the taxing n o p r o v i s i o n . In S.I. Burland Properties Ltd. v. M.N.R. ° the non-resident owner of a r e a l property had leased i t to a resident and had covenanted with the lessee that the l a t t e r would pay not only the r e n t a l but a l s o the taxes on the property. Following a contention of the Revenue the question arose whether the land tax amounts ought to have been deemed part of the r e n t a l p r i c e and so taxed. The Exchequer Court held that, notwithstanding the amount was f i x e d and paid f o r a c e r t a i n time, the property tax payment could be considered n e i t h e r as a rent nor a s i m i l a r payment f o r the use of property, f o r tax amounts are not us u a l l y reserved to the landlord.Moreover, under the relevant p r o v i n c i a l s t a t u t e , the o b l i g a t i o n of remitting that tax was imposed with j o i n t l i a b i l i t y to l a ndlord and tenant, so that when the tenant agreed with the l e s s o r to pay tax he was not discharging a les s o r ' s o b l i g a t i o n but only assuming his statutory duty. However, the judgment was reversed by the Supreme Court, which decided,without giving any written reason, that the land tax amounts paid by the tenant i n pursuance of a covenant i n the lease were payments s i m i l a r to rent according to s.106(1)(d)old Act and, therefore,subject to the withholding tax. If the non-resident prefers to hold the property through a company a change i n the tax s i t u a t i o n does not n e c e s s a r i l y r e s u l t . Where a company 78 does not reside i n Canada but owns a property which i t rents to Canadians, without reaching the point where i t c a r r i e s on business i n the country, no corporate income tax w i l l be l e v i e d and no withholding w i l l be imposed on the dividends, as the corporation i s not resident i n Canada. The only tax suffered w i l l be the withholding on rentals exactly as i f the non -resident i n d i v i d u a l owned the property himself. An A l t e r n a t i v e f o r Rents from Real Property Like s.110 old Act the new l e g i s l a t i o n affords a s p e c i a l a l t e r n a t i v e permitting non-resident landowners to be taxed on the net income from rented r e a l properties instead of s u f f e r i n g the withholding tax on gross revenues. S.216(1)I.T.A. reads that i f he chooses to f i l e a return as a normal resident and does i t w i t h i n two years from the end of the taxation year, the non-resident w i l l be l i a b l e to pay income tax under Part I. He w i l l be treated as though he resided i n Canada, his i n t e r e s t i n r e a l property i n Canada were his only source of income — s s . ( b ) — and he were not e n t i t l e d to any deduction from income f o r the purpose of computing income — s s . ( c ) — . Both subsections should be considered with care. Ss.(b), reading that the r e a l t y i s the only income source, enables the non-resident , who i s l i a b l e to pay Part I tax as i f he were a resident, to avoid the world income ru l e [s.3(a)I.T.A.] and so to be taxed only on h i s Canadian r e n t a l income. Being taxable on income from property he w i l l be imposed according to s.9(l) on the p r o f i t (net income) therefrom. In other words he i s allowed to deduct from the gross r e n t a l the expenses 79 he has incurred i n order to earn i t and i n p a r t i c u l a r to deduct the c a p i t a l cost allowances f o r depreciation of the property authorized by s.20(1)(a) and Regulations. The p r o f i t so determined w i l l i t s e l f c o n s t i t u t e the taxable income, the taxpayer being deprived by ss.(c) of the r i g h t to claim personal exemptions and deductions. The consequence of being allowed to deduct c a p i t a l cost allowances i s that, when the property i s disposed of, the excess of the proceeds over the undepreciated c a p i t a l cost (up to the c a p i t a l cost) i s to be included i n the income (s.13 I.T.A..recapture) reported i n the return f o r that taxation year (to be f i l e d w ithin the normal time,s.150) [s.216 (5)I.T.A.]. The rule applies only i f there i s some recapture [s.216(6) I.T.A.]. The o l d Act afforded the r e l i e f of an averaging p r o v i s i o n only i n the event that the non-resident had used that a l t e r n a t i v e f o r the l a s t f i v e years without i n t e r r u p t i o n . Under the new law, s.216(7) simply provides that the non-resident, although imposed as a resident, i s not allowed to r e s o r t to the forward averaging p r o v i s i o n (s.61) normally r e s t r i c t e d to r e s i d e n t s . The taxpayer i s e n t i t l e d to average the income of the year of d i s p o s i t i o n of the property by means of the general formula (s.118). For the non-resident having chosen the a l t e r n a t i v e of being imposed under Part I i t does not follow that the resident payor or tenant i s discharged from the o b l i g a t i o n of deducting and remitting the amount 80 of the withholding tax. According to s.216(2)1.T.A. the remittance on behalf of the non-resident i s simply deemed to have been made on account of Part I (rather than Part XIII) income tax. If there is any overpayment the amount i n excess w i l l be refunded to the non-resident. A particular option of withholding the tax amount is granted to the agent of the non-resident i f the latt e r undertakes to f i l e the return within six months (instead of two years) of the end of the taxation year [s.216(4)]. The non-resident might be interested in employing a trustee resident in Canada to hold the real property on his behalf. Such an arrangement, however, may imply some undesirable consequences. If the using of a trustee created a trust (subdiv. k I.T.A.) the non-resident would no longer be entitled to the s.216 election nor to the benefit of a capital cost allowance. In fact the non-resident would be a beneficiary from a trust residing in Canada and would suffer withholding tax on income from the trust [s.212(1)(c)I.T.A.]. The amounts received by him would not be paid to him on account of rent on real property and therefore s.216 would 99 not be applicable . The alternative of s.216(s.110 old Act) is provided only for real property as the statute clearly prescribes. This was pointed out, i f the Act 100 required, by the Exchequer Court in Lea-Don Canada Ltd. v. M.N.R. . It was held that a non-resident leasing an aircraft to a resident could not have elected under s.110 old Act. 7 81 5. ROYALTIES A. In General As was s a i d under paragraph 4, r o y a l t i e s are dealt with separately only f o r the p r a c t i c a l purpose of organization, i t being c l e a r l y impossible to draw a c l e a r d i s t i n c t i o n with r e n t a l payments. The taxing provisions [s.212(1)(d)(i) to (v)I.T.A.] are the same as under the o l d statute a f t e r s . l 0 6 ( l ) ( d ) was r e v i s e d i n 1968-69. The main purpose of that r e v i s i o n was removal of any doubt about taxation of payments flowing to non-resident persons f o r technical assistance and know-how s e r v i c e s . That explains why the statutory rule contains such a d e t a i l e d l i s t of taxable payments. More simply, i t appears that withholding tax i s l e v i e d on r o y a l t i e s or s i m i l a r payments which residents pay or c r e d i t to non-residents : 1) f o r the use of or the r i g h t to use i n Canada any property — i n v e n t i o n , patent,trade mark, secret p r o c e s s — or other thing whatever, or payments which are dependent upon use of or production from property (whether or not such payments are instalments on the sale p r i c e ) ; 2) f o r industrial,commercial and s c i e n t i f i c information and services the consideration f o r which depends on use,production,sale or b e n e f i t therefrom; 3) for abstaining from use of such things or information. To be added are timber r o y a l t i e s [s.212(1)(e)I.T.A.] provided i n a s p e c i a l r u l e , because the common law concept of timber r o y a l t y i s d i f f e r e n t 82 from that for taxation purposes . The payees of such royalties are offered, as are non-residents receiving rents, the choice of electing for the alternative of s.216 I.T.A. and so of being liable for Part I tax on the net income. The statute exempts from Part XIII tax payments in pursuance of bona fide reasonable cost share arrangements for research and development expenses in exchange for an interest i n properties resulting therefrom. It also exempts payments from a resident dealing at arm's length with the recipients i f the payor may deduct the amount when computing the profit from a business carried out in another country. The most important exemption is of royalties paid on copyright [s.212 (1)(d)(vi),(viii),(x)I.T.A. The tax rate of 25 % [s.212(1)] w i l l be only 15 % up to the end of 1975 [s.lO(2)(a)Rules]. B. Know-how Payments Even without employing the term "know-how" the courts had to deal with the problem of payments for technical assistance, as in Warsh & Co. Ltd. v. M.N.R.iQ? A Canadian company had obtained the exclusive Canadian rights to the dress designs of a non-resident for a yearly base payment plus a percentage of the sale proceeds. The agreement provided that the "lessor" would also furnish some information, help and advice. The 83 Tax Appeal Board decided that the s e r v i c e s were i n d i v i s i b l e from the r i g h t s l i c e n s e d , were a parcel of such r i g h t s and that the f u l l payments, i . e . the f i x e d base plus the percentage, were r o y a l t i e s or s i m i l a r payments. The problem, however, became more complex when the j u d i c i a l a u t h o r i t i e s were faced with know-how l i c e n s i n g agreements and know-how sa l e s . To determine whether the payments based upon a know-how l i c e n s i n g agreement are r o y a l t i e s (or s i m i l a r ) and as such subject to the withholding tax, when flowing to non-residents, one had to examine the nature of 'know -how", the nature of the r o y a l t i e s and whether know-how constituted a property. About the nature of know-how the House of Lords observed i n Rolls-Royce 103 Ltd. v. J e f f r e y that i t i s " an ambience that pervades a h i g h l y s p e c i a l i z e d production organization". Giving concrete examples one.of the 104 speakers at the 1964 I n t e r n a t i o n a l Corporate Tax Conference explained that "know-how may take the form of management s k i l l , t e c h n i c a l a b i l i t y , f i n a n c i a l means, patent p r o t e c t i o n , a w e l l developed trade mark or trade name, or whatever else contributes to the success of an e n t e r p r i s e " . The second issue concerned the nature of r o y a l t i e s . As mentioned, r o y a l t y i s not e a s i l y d i s t i n g u i s h a b l e from rent. Royalty has not a precise t e c h n i c a l or l e g a l meaning so there must be recourse to meanings established by i n d u s t r i a l and commercial usage. Royalty may be described as compen- sat i o n dependent upon use, production, or benefit,and r e n t a l described as a f i x e d payment r e l a t e d to a time measurement^-0^ Payments f o r know -how,although generally computed by reference to production therefrom, 84 have not always been considered r o y a l t i e s . The R o l l s Royce case appears to suggest that payments f o r know-how based on production or use may be l i k e r o y a l t i e s''in the sense that the measure of these recurrent payments i s taken to be so many pounds s t e r l i n g per engine manufactured and a fi x e d percentage of the commercial s e l l i n g p r i c e " . But they were not concluded to be r o y a l t i e s , perhaps because they were not payments made f o r the rendering of s e r v i c e s . That was the conclusion of one Lord i n English E l e c t r i c Co. v. Musket^^ who suggested that i n making know-how a v a i l a b l e these companies were teaching f o r reward and that the payments constituted remuneration for a s e r v i c e . The r e s u l t of both B r i t i s h decisions has been the drawing of a d i s t i n c t i o n between payments r e l a t e d to services and so entering the income from trade or business, and payments r e l a t e d to the use of property, so being the return from investment or mere passive ownership. The d i s t i n c t i o n i s s i m i l a r to that already established i n the U.K. regarding revenue 107 from patents In Canadian jurisprudence the p r i n c i p l e of the Rolls Royce case was 108 followed i n Technical Tape Corp. v. M.N.R. . A Canadian company had obtained know-how — t e c h n i c a l and engineering a s s i s t a n c e — from an American corporation. The Canadian company paid a c o n t r a c t u a l l y f i x e d amount i n some years and a percentage of the sales i n others. A f t e r s t a t i n g , without i n d i c a t i n g any reason, that the f i x e d amounts were not i n the nature of a rent or ro y a l t y as they had been a r r i v e d at by nego t i a t i o n and mutual agreement, the Tax Appeal Board held that the other payments (percentage on sales) were i n the nature of r o y a l t i e s because they were 85 c a l c u l a t e d on the extent of the use made by the resident of the know-how supplied to him. In the ana l y s i s of the character of r o y a l t i e s one thing seemed to be beyond dispute : the term was o r d i n a r i l y used to describe compensation f o r the use of, or the r i g h t to use property. To c o n s t i t u t e a roy a l t y a payment had to flow from property ( s t i l l . c f . s.212(1)(d) (i)I.T.A.) and property i n t h i s sense may be tangible or i n t a n g i b l e 109 and includes proprietory r i g h t s . Thus, i n order to determine whether payments f o r know-how were r o y a l t i e s or s i m i l a r to r o y a l t i e s , the f i n a l and e s s e n t i a l question was that of determining whether the know-how was a property. In Evans Medical Supplies Ltd.v. M o r i a r t y ^ 0 , a know-how sale case i n which the issue was whether a lump sum con s t i t u t e d c a p i t a l or income r e c e i p t , the House of Lords held that secret processes and information composed a valuable property or business asset of the taxpayer. In Rolls Royce Ltd. v. J e f f r e y again i t was asserted that the know-how i s undoubtedly an asset, even though i t may be an in t a n g i b l e one which never becomes depleted. Relying on the support of such an authority the Board stated in..! Technical Tape Corp. v. M.N.R. that without doubt the know-how was to be regarded as "propertyV i n accordance with the d e f i n i t i o n of s.139(1)(ag)old Act [s.248(1)I.T.A.] which reads : "property" means property of any kind whatever whether r e a l or personal or corporeal or incorpo- r e a l and, without r e s t r i c t i n g the generality of 86 the foregoing, includes a r i g h t of any kind ' whatever, a share or a chose i n a c t i o n . So the payments (found to be i n the nature of r o y a l t i e s ) were held to be r o y a l t i e s or s i m i l a r payments f a l l i n g within s.106(1) (d)old Act. Thereafter i t seemed that knowledge, expertise, information would beyond any doubt be declared to be property. In a l a t e r case the Exchequer Court rendered a dec i s i o n along the same l i n e : the c o n f i d e n t i a l t e c h n i c a l information (which was highly valuable, j e a l o u s l y guarded proprietary information), supplied by a non-resident to a resident corporation i n return of fees at s p e c i f i e d rates based on'sales, was sa i d to form trade secrets (analogous to secret processes) and could be c l a s s i f i e d as "other l i k e property" — the term being contained i n the Canadian-American Reciprocal Tax Convention - and, therefore, the fees were r o y a l t i e s f o r the use of te c h n i c a l information, taxable under s.106(1)(d)old Act (Western E l e c t r i c Co. Inc. v. M.N.R.)"*"11 It was dif f i c u l t , h o w e v e r , to say whether such a conclusion could be considered an absolute one. Two years e a r l i e r the same Court, judging a case s i m i l a r to the e a r l i e r , above, where the members of an American coop-association by paying dues,fees and mechanical charges were allowed to use the trade-name and to receive d i f f e r e n t types of assistance (on production, q u a l i t y c o n t r o l , a d v e r t i s i n g , marketing and organization of seminars), rejected the d i s t i n c t i o n operative i n English jurisprudence between know-how as property and know-how as s e r v i c e . The Court held that the know-how provided had to be categorized i n any event not as "property" or "other thing". The consequence was that no withholding 87 was to be retained (Quality Chekd_Dajyry_JLrojjugAgL A s J L ' j l IL'-JJiAdts) Obviously the i n c e r t a i n t y about the state of the law was great and 113 i t was d i f f i c u l t to foresee the courts' decisions The replacement of s.106(1)(d)old Act i n 1968-69 with a new d e t a i l e d l i s t of s i t u a t i o n s i n which payments flowing to non-residents are considered to be r o y a l t i e s or s i m i l a r payments (corresponding to s.212(1)(d)I.T.A.) should avoid any doubt as to the a p p l i c a t i o n of the withholding tax to know-how supplies. The statutory p r o v i s i o n expressly describes as r o y a l t i e s or s i m i l a r payments those fees computed on a proportional basis f o r t e c h n i c a l information and s e r v i c e s . C. Motion Picture Films Like the old l e g i s l a t i o n , t h e new Act contains a s p e c i a l section providing that the withholding tax s h a l l be l e v i e d on r o y a l t i e s paid to a non-resident for a r i g h t i n or the use of motion p i c t u r e films or film s or video tapes r e l a t e d to t e l e v i s i o n and used or reproduced i n Canada [s.212(5)I.T.A.]. It i s i n t e r e s t i n g to note that a l l payments made f o r a right i n or the use of f i l m s that are to be reproduced i n the country are comprised wit h i n the meaning of the statutory p r o v i s i o n , whether or not such r i g h t s are derived from an outright purchase, as the Exchequer Court 88 decided i n N.664 v. M.N.R. According to s.l06(2)old Act the tax withheld on such r o y a l t i e s amounted to 10 %, which means that i t was lower than the normal 15 % withholding r a t e . The t r a n s i t i o n a l provisions of the new B i l l w i l l maintain the preferred rate of 10 % u n t i l the end of 1975 [S.10(2) (c)I.T.A.]. A f t e r that date the tax w i l l increase to 25 %,so being equal to the withholding retained on other non-residents'incomes from Canada. 6. MANAGEMENT FEES The withholding tax applies to management administration fees or charges paid or cred i t e d by resident persons to non-residents [s.212(1)(a)I.T.A.]. This r u l e was introduced i n the old Act i n 1963 with the main o b j e c t i v e of checking the possible abuses c o n s i s t i n g i n the charging of excessive management fees by f o r e i g n parent companies to Canadian s u b s i d i a r i e s . Payments are taxed i n those circumstances under which the l a b e l of management expense i s used as a facade to withdraw p r o f i t s which would otherwise .be taxable ^ ? What are management and administration services ? The expression r e f e r s to the kind of services r e l a t e d to management consultants —systems 89 development, organization studies, production planning,, market r e s e a r c h — as w e l l as to services furnished by corporations' head o f f i c e s to branches or by parent companies to s u b s i d i a r i e s : a d v e r t i s i n g , insurance, data processing equipment, s p e c i a l t e c h n i c a l departments (legal,engineering, research, i n t e r n a l audit, c r e d i t and c o l l e c t i n g , personnel r e l a t i o n s , p u b l i c r e l a t i o n s , l i b r a r i e s , cost accounting, p r i n t i n g ) and other group expenses on behalf of the operating d i v i s i o n s . This very large grouping includes s e r v i c e s which sometimes can only be performed, because of the necessary f a c i l i t i e s , by head o f f i c e s . I t would, i n other words, comprise a l l business f a c i l i t i e s a v a i l a b l e from the head o f f i c e 1 1 6 . I t soon appears that such an extensive d e f i n i t i o n , proper and j u s t i f i e d when the p r o v i s i o n was enacted, could lead to an overlapping and confusion with the r u l e (as amended i n 1968-69) p r e s c r i b i n g the taxation of r o y a l t i e s or s i m i l a r payments f o r i n d u s t r i a l - c o m m e r c i a l - s c i e n t i f i c information and services [s.212(1)(d)I.T.A.]. C e r t a i n l y i t could be contended that a d i s t i n c t i o n would probably l i e i n the method of c a l c u l a t i o n of the fees, the r o y a l t i e s f o r know-how depending upon the production or p r o f i t therefrom and the management charges being generally more f i x e d . But that i s not n e c e s s a r i l y true. A case l i k e that of Technical Tape C o r p . 1 1 7 shows that know-how consideration may be f i x e d and, on the other hand, administration charges could also be computed i n a proportionate way. So a more r e s t r i c t e d conception would seem appropriate i t having been stated i n Parliament that the government intended to impose amounts paid f o r advice or d i r e c t i o n p e r t a i n i n g to the operation or administration of a company, not i n c l u d i n g those paid f o r i d e n t i f i a b l e s e r v i c e s ( t r a n s p o r - 90 118 t a t i o n , insurance, a d v e r t i s i n g , accounting and research) . In support of a narrower view i t has been suggested that the p r o v i s i o n w i l l only apply, as a matter of law, to payments for the kind of thing or a c t i v i t y that a board of d i r e c t o r s and the top executive management of a corpo- 119 r a t i o n would themselves perform i n the current business operations . The withholding i s t h e o r e t i c a l l y not l e v i e d on a l l management fees paid to non-residents, as s.212(4)1.T.A. avoids t a x a b i l i t y : - of s e r v i c e s performed by a non-resident i n the ordinary course of a business, i n c l u d i n g such services f o r consideration, provided that he deals at arm's length with the payor : - of s p e c i f i c expenses reimbursed to a non-resident who incurred them i n rendering a service that was f o r the payor's b e n e f i t . The general condition is,moreover, that the amount was reasonable i n the circumstances. But the e f f e c t i v e n e s s of s.212(4) i s l i m i t e d because i t requires arm's length r e l a t i o n s h i p s but p r i m a r i l y applies to transactions that u s u a l l y occur between parent companies and t h e i r s u b s i d i a r i e s . It i s understandable that Canadian s u b s i d i a r i e s of foreign corporations may f i n d i t u s e f u l to "pay" the parent companies high management fees and administrative charges, so minimizing t h e i r own corporate income tax and the withholding tax suffered by the parent companies on s u b s i d i a r i e s ' d i v i d e n d s . It has been suggested, with some tentativeness,that the p r o v i s i o n taxing the management fees, being p a r t i c u l a r l y intended to prevent abuses i n inter-company p r i c i n g , was perhaps dispensable. L e g i s l a t i o n has other means of counteracting such abuses. In fact administration charges 91 i n excess of a reasonable amount are not deductible [s.67 I.T.A.; s.12 (2)old Act],only the reasonable portion being allowed [s.69(2)I.T.A.] [s.17 old A c t ] . The excess i s treated as a dividend flowing to non-resident shareholders according to s.214(3) [s.lOS(5)old Act] i f i t i s an i n d i r e c t 120 payment or t r a n s f e r or appropriation of funds It i s i n t e r e s t i n g to notice that the law excludes t a x a b i l i t y of management fees using two d i f f e r e n t c r i t e r i a . In one s i t u a t i o n , which could only e x i s t between independent p a r t i e s because an arm's length r e l a t i o n s h i p i s required, the exemption [s.214 (3)(a)I.T.A.] concerns the whole reasonable amount paid f o r management services to a non-resident dealing at arm's length. The concept of arm's length value i s the same as that one employed i n s.69(2) to l i m i t the p r i c e which the resident i s e n t i t l e d to deduct as an expense. On the arm's length value b a s i s ^ O underlying costs are almost ignored and the fees are determined according e i t h e r to an estimated market value of the services furnished or to the value of the benefits received. The other s i t u a t i o n i s one p a r t i c u l a r l y u s e f u l f o r inter-company s e r v i c e s , as no arm's length i s required. The statute [s.214(3)(b)] exempts from withholding tax the portion of the charge that corresponds to s p e c i f i c costs incurred by the non-resident performing the s e r v i c e s . But such costs must be reasonable. The c r i t e r i o n of cost l e v e l appears to c o n f l i c t with the arm's length value prescribed i n s.69(2) as to the d e d u c t i b i l i t y 120 of the payment (not only the costs) for the payor. On the cost basis a c t u a l expense cons t i t u t e s t o t a l charge and the payee — u s u a l l y the company or the head o f f i c e — does not r e a l i z e any p r o f i t or incur any l o s s . 92 In the event that management services are performed in favour of Canadian residents outside Canada, the withholding tax of s.212(1)(a) becomes a protectionist duty much more than an income tax, as the statute reads. And what i f the services are rendered in Canada ? Before the 1968-69 amendment of s.106(1)(d)old Act i t was suggested 1 2 1, by reference 122 to United Geophysical Co. of Canada v. M.N.R. (relating to technical service more than management), that such services would constitute carrying on business in Canada. In this event non-residents would have been caught under s.2(2) and 31 old Act and exempted from withholding tax by s.805 old Regulations. It now may be contended, especially when accepting a restricted conception of management services as distinguished from technical services and information (covered by s.212(1)(d)I.T.A.), that management and administration activity does not constitute carrying on business in Canada even i f performed in the country: i t is not covered by the extended meaning of carrying on business in Canada given i n s.253. The same thought may be extended to technical information and know-how services as referred to in the Act after the 1968-69 amendment. In such case there would not be any reason for imposing profit under Part I I.T.A.. The imposition could only be through withholding tax. 7. TRUST AND ESTATE INCOME Income flowing from a trust or estate to non-resident persons are 3 93 subject to the withholding tax [s.212(1)(c)I.T.A.]. The taxing provision applies to a l l payments made by a trust to beneficiaries or other persons beneficially interested (otherwise than on capital distribution) regardless of the source from which the trust, derives the gain [s.212(11)1.T.A.]. Thus i t has been mentioned under paragraph 4 that a non-resident owning real estate or timber right may be at a disadvantage i f he chooses to hold i t through a Canadian trustee, for he w i l l be deprived of the alternative of s.216. Beneficiaries residing in other countries and suffering the withholding tax on the gross amounts of their receipts [s.214(1)I.T.A.] may not benefit at a l l by capital cost allowances and depletion allowances to which resident beneficiaries are entitled according to s.104(16) and (17). With particular reference to depletion deduction which a trustee desired in computing the trust's income from royalties on o i l wells before distributing income to non-resident beneficiaries, i t was held that no depletion allowance — a mere deduction from income-- could be claimed according to the withholding tax rule (Rational 123 Trust Co Ltd., trustee of S.Gorman v. M.N.R.) The withholding tax is not imposed in some cases. One exemption concerns trusts created before 1949 a l l the beneficiaries of which reside i n the same foreign country from which the trust i t s e l f receives the whole of i t s income: s.212(18). Another exemption applies to situations in which the trust i s only an 94 intermediate, the e f f e c t of which would be to deny the b e n e f i c i a r i e s some p r i v i l e g e s granted to them i f they acted personally.So i f non -resident b e n e f i c i a r i e s ' income from a t r u s t may reasonably be regarded as r o y a l t i e s which the t r u s t earned on copyright (normally non-taxable, s.212(1)(d)(vi)), no Part XIII tax w i l l be withheld, according to s.212 (9)(b)I.T.A. The same i s provided for those i n t e r e s t s and dividends, other than taxable or c a p i t a l dividends, which a non-resident-owned investment corporation d i s t r i b u t e s to a trustee — s . 2 1 2 ( 9 ) ( a ) — . The condition i s the reasonableness of the amount then paid on t h i s basis to the b e n e f i c i a r i e s . This r u l e makes the exemption app l i c a b l e only to dividends given out of tax-paid undistributed income and 1971 c a p i t a l surplus [s.83(1)I.T.A.]. However, the corporation must have complied with the prescribed e l e c t i o n , f o r i f i t does not e l e c t then such dividends are taxable [s.89(1)(j)I.T.A.]. In contrast to s.106(4) o l d Act the r e s t r i c t i o n regarding such dividends i s owing to the fact that now dividends d i s t r i b u t e d by non-resident-owned investment corporations are no longer tax-free. According to s.212(1)(c) income from t r u s t s does not include b e n e f i - c i a r i e s ' designated c a p i t a l gain. According to s.104(21) a t r u s t may designate a portion of i t s net c a p i t a l gain, that can reasonably be considered to have been part of the t r u s t income (paid or payable) of a b e n e f i c i a r y , as being taxable c a p i t a l gain of that b e n e f i c i a r y from d i s p o s i t i o n of c a p i t a l property.Because of the designation such portions of c a p i t a l gain could be deducted i n computing the income of the t r u s t and included i n the income of the designated b e n e f i c i a r y . 95 In the event that the p a r t i c u l a r b e n e f i c i a r y i s a non-resident person, s.l04(9) p r o h i b i t s the t r u s t from claiming any deduction. For that reason no withholding tax w i l l be l e v i e d on that part of the bene- f i c i a r y ' s income. If no designation i s made by the t r u s t under s.104(21) the non-resident be n e f i c i a r y w i l l s u f f e r the withholding tax on a l l his t r u s t income. It i s noticeable that property, i n respect of which the t r u s t may a l l o c a t e a portion of taxable c a p i t a l gains to a b e n e f i c i a r y , must only be a c a p i t a l property. S.54(b) defines as c a p i t a l property any depreciable property of the taxpayer and any other property on d i s p o s i t i o n of which the taxpayer would pay c a p i t a l gain taxes (or claim c a p i t a l l o s s e s ) . If the non-resident owned d i r e c t l y (instead of through the t r u s t ) he would according to s.2(3)(c) be taxed only on c a p i t a l gains r e a l i z e d on taxable Canadian property, which comprises a c e r t a i n number of items l i s t e d i n s.115(1)(b)I.T.A. ( r e a l t y , business property, shares, c a p i t a l i n t e r e s t i n t r u s t s ) . When a trust makes payments to i t s b e n e f i c i a r i e s the amounts so paid are deductible i n c a l c u l a t i n g the trust income [s.104(6)1.T.A.]. I f the payable b e n e f i c i a r i e s are non-residents no deduction i s allowed unless the t r u s t i t s e l f i s resident i n Canada [s.104(7)I.T.A.]. However, when a l l the property i s owned by the trustee f o r the exclusive benefit of non-resident b e n e f i c i a r i e s or t h e i r unborn issue, dividends and i n t e r e s t which the t r u s t receives from non-resident-owned investment corporations are deductible by the t r u s t even though they are not 96 payable to the non-resident b e n e f i c i a r i e s i n the year [s.104(10)]. The Act provides, moreover, that such dividends s h a l l be deemed tran s f e r r e d as t r u s t income to the b e n e f i c i a r i e s — s . 1 0 4 ( 1 1 ) — and so submitted to the withholding tax [s.212(1)(c)I.T.A.]. F i n a l l y , when the non-resident i s b e n e f i c i a r y of an i n t e r vivos t r u s t doing business i n Canada the t r u s t i s disallowed by s.104(8) any deduction f o r amounts i t pays to the b e n e f i c i a r y . Such amounts s u f f e r Part XIII tax. 97 V. THE NON-RESIDENT-OWNED INVESTMENT CORPORATION The non-resident-owned investment corporation (NRO) provided by s.133 I.T.A. (s.70 old Act) constitutes an u s e f u l v e h i c l e for non -residents who wish to invest i n Canada or to make t h e i r i n t e r n a t i o n a l investment operations from a Canadian basis and p r e f e r to do that through a company. The e f f e c t of the rules r e l a t i n g to NROs i s u l t i m a t e l y to tax the non-resident shareholders of such companies i n the same manner as they would have been taxed i f they had invested d i r e c t l y . The concept of NRO i s e s s e n t i a l l y the same as under the o l d l e g i s l a t i o n , the NRO being a company whose shareholding s u b s t a n t i a l l y belongs to non-residents and whose a c t i v i t i e s and earning sources are l i s t e d i n the s t a t u t e s . The new law, however, i s somewhat more r e s t r i c t i v e . In order to q u a l i f y as an NRO, a company has to meet some supplementary requirements as to the shareholding and as to the continuity of the NRO q u a l i f i c a - t i o n . A mayor change i s that dividends flowing to non-resident shareholders are now subject to the withholding tax, except i n the case of s p e c i a l dividends. This does not imply that NROs are taxed twice, as both company's p r o f i t and dividends. The new B i l l introduces,as i n other matters, a system refunding the prepaid corporate s p e c i a l income tax when the NROs d i s t r i b u t e taxable dividends. The refund i s not t o t a l , only applying to tax paid on income, not on c a p i t a l gains. Moreover, 98 the tax rates have increased. Therefore NROs and t h e i r shareholders now s u f f e r a heavier tax burden. The new provisions are complicated and they contain new concepts based on highly t e c h n i c a l d e f i n i t i o n s . A. D e f i n i t i o n To q u a l i f y as a NRO a company has to meet a l l requirements set out i n s.70(4)old Act. . The i n c o r p o r a t i o n has to take place i n Canada so that the company w i l l n e c e s s a r i l y be resident i n t h i s country. The company must have been continuously an NRO from June 18,71. u n t i l the end of the relevant taxation year. If i t has been created l a t e r , the corporation must always have been an NRO. This condition of c o n t i n u i t y was non-existent under the old Act. Another new p r e s c r i p t i o n i s that i f the corporation r e s u l t s from an amalgamation a f t e r the Budget Day 1971 the merging companies had themselves to be NROs. A l l companies' bonds.debentures and other funded indebteness must be b e n e f i c i a l l y owned by non-residents other than f o r e i g n a f f i l i a t e of residents or by t h e i r trustees or by other NROs. The same rule applies to a l l issued shares. Because under the previous system such p r e s c r i p t i o n only concerned 95 % of the shareholding, s.59(2) A p p l i c a t i o n Rules prescribes that the 95 % requirement instead of 100 X l a s t s u n t i l 19 76. The income of the company may only derive from : ownership of or trading and dealing i n bonds, shares, debentures, mortgages, b i l l s , or notes; lending money; rents, h i r e of c h a t t e l s , or charterparty fees 99 up to a maximum of 10 % of the gross revenue; i n t e r e s t , dividends and r o y a l t i e s ; estates and t r u s t s ; or d i s p o s i t i o n of c a p i t a l property. It i s important to stress that the income may o r i g i n a t e from Canadian or f o r e i g n sources^ The p r i n c i p a l business of the company must not be the making of loans, trading or dealing i n s e c u r i t i e s . F i n a l l y , the company must e l e c t and not revoke under t h i s s e c t i o n within 90 days of the commencement of i t s f i r s t taxation year a f t e r 1971. A l l NROs, even i f they have elected to be treated as such i n the past, must r e e l e c t under the new Act or incur the loss of t h e i r s t a t u s 1 2 4 When a company complies with a l l these statutory conditions i t then q u a l i f i e s as an NRO and i s e n t i t l e d to s p e c i a l tax treatment. Sometimes doubts may a r i s e about the q u a l i f i c a t i o n of a corporation 124a as an NRO. In Cayuga Realty Ltd. v. M.N.R. the Revenue argued that an NRO ( a l l shares of which were owned by non-residents), which had acquired two parcels of revenue-producing r e a l estate, and which had p a r t i a l l y paid the p r i c e and p a r t i a l l y assumed a mortgage (which had three years to run) i n favour of a Canadian resident, was no longer an NRO. The Tax Appeal Board refused to accept the contention and held that the p r e s c r i p t i o n of s.70(4)(a)old Act [s.133(8)(d)(i)I.T.A.] r e f e r r e d to the c a p i t a l structure of the corporation and not to assets i t acquires i n the course of the business. The Board a l s o s a i d that r e a l estate mortgages are not included i n funded indebtedness. In another case a company p r i n c i p a l l y involved i n stock and bond investment had given a sub-guarantee for two loans and received for 7 100 that a "commission'1. It was decided the company was not allowed to q u a l i f y as an NRO. The corporation, i n f a c t , had engaged i n the business of providing guarantees and money i t received was the reward of a personal s e r v i c e . The payments were neither attached to the ownership of assets possessed by the corporation 125 nor income from lending money (N.479 v. M.N.R.) . B. Computation of Income and Tax The law establishes c e r t a i n rules for the purpose of computing the income of an NRO. So c a p i t a l dividends d i s t r i b u t e d by p r i v a t e corporations which generally are not computed as shareholders' income [s.83(2)(b)] are to be included i n the income of an NRO shareholder i n a pri v a t e corporation : s . l 3 3 ( l ) ( e ) . In contrast with the other taxpayers f o r whom only one h a l f of the c a p i t a l gains are taxable, an NRO must include i n i t s income the f u l l amount; of c a p i t a l gains or deduct the f u l l amount of c a p i t a l l o s s e s : s.133(1)(c)+(d)I.T.A.. The only c a p i t a l gains taken i n t o account are those r e a l i z e d on taxable Canadian property, as defined i n s.115(1)(b) i n regard to taxation of c a p i t a l gains r e a l i z e d by non-residents. In r e l a t i o n to NROs, taxable Canadian property comprises r e a l estate i n Canada, shares i n pri v a t e corporations, and shares i n p u b l i c corporations i f the NRO owns or controls not less than 25 % of the issues shares. The r e s u l t of t h i s d e f i n i t i o n i s to permit an NRO to make tax-free 101 c a p i t a l gains on the s a l e of non-Canadian investments and on c e r t a i n Canadian investments. This i n accordance with the l e g i s l a t o r ' s 126 i n t e n t i o n of taxing an NRO to the same e f f e c t as a non-resident When c a l c u l a t i n g the p r o f i t of the corporation no deduction may be made f o r mining depletion allowances nor f o r i n t e r e s t paid on bonds, debentures, s e c u r i t i e s and other indebtedness : s.133 (1)(a)+(b). This l a t t e r constitutes a major p r o h i b i t i o n . The expression "other indebtedness" has to be broadly i n t e r p r e t e d , as the Exchequer Court held i n Peninsular Investments Ltd. v. M.N.R.1 The Court decided that such terms cover not only o b l i g a t i o n s secured or evidenced by s e c u r i t i e s but also o b l i g a t i o n s a r i s i n g even from transactions other than borrowing. The reason why an NRO i s denied to deduct any i n t e r e s t i t pays o f f i s that such i n t e r e s t flowing to non-residents i s exempt from withholding tax. This r u l e may seem i n t e r e s t i n g f o r non-residents who have financed the company by lending money rather than by a c q u i r i n g equity. But i t i s not i n favour of the NRO i t s e l f or of the shareholders who only own stock, for the company s u f f e r s on these non-deductible amounts i t s own income tax, which i s p r a c t i c a l l y equivalent to the withholding tax. Having l e s s a f t e r - t a x p r o f i t a v a i l a b l e for dividends i t cannot obtain any refund f o r that part of i t s income tax. Other ordinary business expenses are normally deductible i n order to determine p r o f i t . 102 No deductions from the net income are allowed when c a l c u l a t i n g the taxable except those s p e c i f i c a l l y l i s t e d i n S.133(2). These possible deductions are i n t e r e s t s received from other NROs; net c a p i t a l losses c a r r i e d over from the years ( and to be applied only against c a p i t a l gains); and f o r e i g n tax paid, the NROs not being e n t i t l e d to for e i g n tax c r e d i t [s.133(4)1.T.A.]. On i t s taxable income the NRO w i l l pay tax computed at a s p e c i a l rate of 25 % as stated i n s. 133(3). However, t h i s comparatively simple taxation system w i l l not apply u n t i l 1976, as another scheme i s provided f o r the t r a n s i t i o n period 1972-75 by c l . 5 9 ( l ) ( a ) A p p l i c a t i o n Rules. The corporate tax w i l l be c a l c u l a t e d as follows: - 25 % of the lesser of the taxable income or the ( f u l l ) net c a p i t a l gains ( i . e . a f t e r deduction of c a p i t a l losses suffered i n the year and c a r r i e d over) on taxable Canadian property; plus - 15 % of the excess, i f any, of taxable income over net c a p i t a l gains. That means that c a p i t a l gains of the NRO w i l l s u f f e r a 25 % tax from 1972, whereas i t s other income w i l l be taxed at 15 % u n t i l the end of 1975 and then at 25 %. In regard to t h i s t r a n s i t i o n a l rule the new B i l l has been amended so as to make the 25 % tax on c a p i t a l gains immediately e f f e c t i v e . The tax remitted by an NRO i s not d e f i n i t i v e , f o r part of i t w i l l be refunded upon d i s t r i b u t i o n of dividends —now caught under 103 Part XIII t a x — by the company, as w i l l be seen l a t e r on. C. Dividend D i s t r i b u t i o n Discussion of d i s t r i b u t i o n of dividends requires that a d i s t i n c t i o n be made between taxable dividends and exempt dividends. In contrast with the old l e g i s l a t i o n taxable dividends n e c e s s a r i l y paid out to non-resident shareholders w i l l now s u f f e r withholding tax, f o r there i s no longer an exemption r u l e . According to s.133 (8)(e) taxable dividends do not include c a p i t a l gains dividends. By v i r t u e of s.212(2) NRO c a p i t a l gain dividends are exempted from withholding tax, which applies only to taxable dividends. By means of the general p r i n c i p l e of s . 8 9 ( l ) ( j ) dividends out of the tax-paid undistributed income or 1971 c a p i t a l surplus on hand, i f so e l e c t e d , are not taxable dividends and therefore are not 128 subject to withholding tax [s.212(2)I.T.A.]. I t appears that such p r o v i s i o n concerns NROs too, f o r they are Canadian corpora- tions i n accordance with s.89(1)(a), as required by s.83(1)I.T.A. This opinion f i n d s confirmation i n the new B i l l ' s p r e s c r i p t i o n s on the computation of NROs'1971 undistributed income and c a p i t a l surplus as w e l l as i n s.134, which says that a NRO cannot be considered a Canadian corporation except f o r the purposes of c e r t a i n s e c t i o n s . To summarize, the withholding tax — 1 5 % u n t i l 1976 and then 25 % — i s l e v i e d on dividends other than c a p i t a l gains dividends and those 104 out of undistributed surplus i f the necessary e l e c t i o n has been f i l e d . Before i t was amended the new B i l l did not allow d i s t r i b u t i o n of tax-free dividends out of accumulated c a p i t a l gains. The tax burden (50 % of the gains).would have been so heavy that shareholders would have preferred to act d i r e c t l y , and paying a maximum tax of 30 % (60 % of hal f the gains), rather than through an NRO. The new s.133(7.1) reads that an NRO may decide to d i s t r i b u t e c a p i t a l gains dividends. The conditions are that the company have no 1971 un d i s t r i b u t e d income on hand, that the amount so designated not exceed the c a p i t a l gains dividend account and that the company r e g u l a r l y so e l e c t . The payment of such tax-free dividends depends, as mentioned, on the " c a p i t a l gains dividend account" a new f i g u r e defined by s.133(8) (c) as: - the c a p i t a l gains of a l l years a f t e r 1971, ending at the time of e l e c t i o n , from d i s p o s i t i o n s of Canadian property (whether or not taxable) and of shares of other NROs; plus the c a p i t a l gains dividends received from other NROs; - minus the aggregate of : the c a p i t a l losses from disposals of Canadian property or shares of other NROs; 25 % of the net c a p i t a l gains — t h e y have been f u l l y included when computing the corporation's income— on taxable Canadian property; the c a p i t a l gains dividends paid by the NRO 105 a f t e r 1971. 128a This p r e s c r i p t i o n refers to Canadian property , whether taxable or not, described i n s,133(8)(b) as comprising property other than f o r e i g n property i n the meaning of s.206(2)I.T.A.. I t follows that c a p i t a l gains from non-Canadian property do not ben e f i t from the p r i v i l e g e of being d i s t r i b u t e d as c a p i t a l gains dividends. They can flow to the shareholders only as taxable dividends l i a b l e to Part XIII tax. Even i f the withholding tax i s the only Canadian tax paid on such gains — t h e y are not imposed within the income of the NRO— i t appears that the law, i n con t r a d i c t i o n with the basic philosophy r e l a t i n g to such s p e c i a l status corporations, penalizes the shareholders of the NRO. Otherwise non-residents do not s u f f e r any Canadian tax on fo r e i g n c a p i t a l gains. 129 An NRO may, i f a Canadian corporation, d i s t r i b u t e tax-free dividends out of i t s tax-paid undistributed income and 1971 c a p i t a l surplus i f i t e l e c t s i n accordance with s.83(1)1.T.A. The determination of such 1971 figures i s modified by a s p e c i a l r u l e i n the event that the NRO has been at some previous time a normally taxable corporation. Thus the 1971 undistributed income hand must be diminished by the di f f e r e n c e between that income and the corporation surplus at the end of 1971 f o r the years during which i t was an NRO. This same amount s h a l l then be added when computing the 1971 c a p i t a l surplus on hand: S.133(5). 106 D. Refund of Tax It has been mentioned that income tax paid by the NRO may be refunded i f i t makes dividends a v a i l a b l e to the shareholders, taxable d i v i - dends being subject to withholding tax. The purpose of refunding tax previously paid by the NRO and then assessing withholding tax (perhaps modified by treaty) on dividends i s to ensure that the f i n a l tax burden w i l l r e f l e c t the rate of Part XIII tax properly 130 a p p l i c a b l e to the shareholders The only tax which may be refunded i s the tax paid by the NRO on i t s income but not the portion suffered on i t s c a p i t a l gains or on non-deductible i n t e r e s t . The only way to become e n t i t l e d to a reimbursement i s by d i s t r i b u t i o n of taxable dividends alone [s.133(8) (e) and s.212(2)] since payment of c a p i t a l gains dividends does not count f o r such purpose. The question of how much an NRO may receive back from the Revenue necessitates recourse to new f i s c a l f i g u r e s r e q u i r i n g a very t e c h n i c a l presentation. The amount to which an NRO i s e n t i t l e d i s c a l l e d 'allowable refund"; according to s.133 (8)(a) i t can be expressed through a formula : allowable refund = taxable dividend x allowable refundable tax on land paid i n the year greater of - taxable dividend paid - cumulative taxable income The "allowable refundable tax on hand" i s defined by s.133(9)(a) as: 107 - taxes paid as an NRO during a l l years a f t e r 1971; plus 15 % of the 1972 taxable income ( i f the taxable year s t a r t e d i n 1971) excluding dividends received and deducting dividends paid o f f before the end of 1971; - minus the aggregate of : 25 % of the net ( f u l l ) c a p i t a l gains from d i s p o s i t i o n s of taxable Canadian property a f t e r 1971; 1/3 of i n t e r e s t s paid a f t e r the beginning of the 1972 taxation year (that being 15/85 f o r the t r a n s i t i o n period, cl.59(l)(b)Rules);and the allowable refund f o r the previous years. The "cumulative taxable income" i s described i n s.133(9)(b) as: -taxable incomes for a l l years a f t e r 1971; plus the 1972 taxable income ( i f the taxation year s t a r t e d i n 1971) excluding dividends received and deducting dividends paid out before the end of 1971; - minus the aggregate of : net ( f u l l ) c a p i t a l gains on disposals of taxable Canadian property a f t e r 1971; 4/3 (or 100/85 u n t i l 1976) of the i n t e r e s t paid a f t e r the 1972 taxation year began; the taxable dividends paid since the f i r s t taxation year a f t e r 1971. The allowable refund w i l l be obtained without following any s p e c i a l procedure, s.133(6) simply e s t a b l i s h i n g that the NRO must have f i l e d i t s return within four years of the end of the year, which i s not a severe condition. If the refund i s a v a i l a b l e before the NRO i s assessed, then the Department refunds i t without a p p l i c a t i o n by 108 the taxpayer. But i f the notice of assessment has been mailed before any allowable refund can be obtained, then the NRO must make a p p l i c a t i o n within four years of the end of the taxation year i n order to o b l i g e the Minister to repay. It i s al s o provided [s.133(7)I.T.A.] that where the NRO has or i s going to have other tax l i a b i l i t i e s the allowable refund w i l l not be reimbursed but w i l l be deducted from those amounts. E. C a p i t a l Gains on Sale of NRO Shares It has been s a i d - ^ l that the most obvious i n j u s t i c e i n the manner i n which the new B i l l treates the NROs a r i s e s from the fac t that the non-resident shareholders w i l l be l i a b l e f o r tax on c a p i t a l gains r e a l i z e d on d i s p o s i t i o n s by them of such NRO shares. This i s true and seems to co n t r a d i c t the idea that the NRO need only be a ve h i c l e used by non-residents and that non-residents w i l l not s u f f e r a heavier burden than they would i f a c t i n g personally. The new legislation,however, imposes them on the v a r i a t i o n i n value of the NRO i t s e l f . I t appears that i n any case such tax w i l l be paid indipendently of the percentage shareholding of the non -residents. Even i f an NRO could t h e o r e t i c a l l y be a pu b l i c corporation ( i n which case ownership of 25 % would be a condition of t a x a b i l i t y ) , i t seems improbable that an NRO could comply with the p r e s c r i p t i o n s of s.89(l)(g) + Regulations. Thus the NRO being a company resident i n Canada (other than a p u b l i c corporation), any gain r e a l i z e d by 109 non-residents on d i s p o s i t i o n of shares w i l l f a l l within s.115(1) ( b ) ( i i i ) I . T . A . . The i n j u s t i c e i s i n a double taxation, one generally not intended when taxing NROs and t h e i r shareholders. Part or a l l of the c a p i t a l gains obtained by the shareholders (when disposing of the shares) may be a t t r i b u t e d to gains r e a l i z e d by the NRO i t s e l f on disposals of Canadian property. If such gains were d i s t r i b u t e d to the shareholders they would be tax-free c a p i t a l gains dividends because the gains have already been imposed within the NRO's income. I f the NRO does not d i s t r i b u t e them they increase the value of shares and, when disposed of, create a c a p i t a l gain taxed i n the hand of the shareholders. uo VI. THIN CAPITALIZATION A. In General The new l e g i s l a t i o n introduces p r e s c r i p t i o n s to r e s t r i c t s o - c a l l e d t h i n c a p i t a l i z a t i o n and, at the same time, to prevent one of the easiest types of tax avoidance open to non-residents. Non-resident who wish to operate businesses or to invest through companies r e s i d i n g i n Canada, may f i n d i t advantageous to finance t h e i r corporations by lending money to them rather than by sub- s c r i b i n g share c a p i t a l . This p r a c t i c e i s c a l l e d t h i n c a p i t a l i z a t i o n : the non-residents finance t h e i r Canadian companies through debt o b l i g a t i o n s instead of equity. The i n t e r e s t these companies pay on borrowed funds can be deducted as an expense, thus minimizing p r o f i t s subject to corporate income tax. Of course t h i s device may also be used by residents, but the r e s u l t i s completely d i f f e r e n t f o r Revenue, which can only levy the withholding tax of 15 % or 25 % on lenders who do not reside i n Canada, but would almost surely levy a higher tax on lenders who l i v e i n t h i s country and pay t h e i r income tax at a progressive rate which may exceed the 50 % corporate rate. Moreover, residents are le s s tempted to engage i n debt financing than non-residents, f o r when re c e i v i n g dividends, residents benefit from the dividend tax c r e d i t not a v a i l a b l e to non-residents. I l l Dividends distributed to non-residents represent earnings which have suffered both corporate plus withholding tax, whereas interest payments flowing to non-residents interested i n or controlling companies operating in Canada, represent income only imposed under Part XIII I.T.A. Were i t not for these restrictions, the use of thin capitalization to gain tax advantages would have increased under the new Act, because i t allows resident corporations to write off the interest paid by them on money borrowed for the purposes of acquiring shares in other corporations, thus abolishing the obvious discrimination under the previous act which allowed foreign companies to buy out Canadian entities at terms more advantageous than those available to resident companies. The philosophy which the new provisions are based upon i s implemented when such interest remunerations are treated i n the same manner as dividends. Under some circumstances, interest paid to non-residents is disallowed as a deduction and so remains taxable. Because such interest continues to be lia b l e to withholding tax, the f i n a l result is the same as i f the non-resident had a larger shareholding and received dividends. The determinant circumstances evolve out of the proportion between the corporate equity and the debt outstanding to certain non-residents. The prohibition for the companies to deduct interest affects only a portion of the interest paid to the same non-residents. When the new B i l l was f i r s t enacted, the thin capitalization provisions were extremely severe, because they i 112 prohibited deducting i n t e r e s t payments regardless of the c r e d i t o r , but l a t e r amendments have reduced t h i s s e v e r i t y . B. Loans to Companies The r e s t r i c t i o n of deducting applies to i n t e r e s t to be paid on outstanding debts to s p e c i f i e d non-residents. S p e c i f i e d non-residents are of two types : a) shareholders who, alone or together with persons with whom they do not deal at arm's length own at l e a s t 25 % of the issued shares of any cl a s s and who are e i t h e r non-resident persons or non-resident-owned investment corporations; b) non-resident persons or NROs who do not deal at arm's length with shareholders described above, but hold no shares themselves [s.18(5)(a)I.T.A.]. The c r e d i t o r may a l s o be a resident —a"subsequent l e n d e r " — making a loan to the company because another taxpayer — a " f i r s t l e n d e r " — has loaned money to him or to another t h i r d person on condition that the subsequent lender lend money to the company [ s . l 8 ( 6 ) ] . It i s submitted that the " f i r s t lender" w i l l probably, but not n e c e s s a r i l y , be a s p e c i f i e d non-resident, f o r s.l8(6) employs the word "taxpayer" rather than " s p e c i f i e d non-resident". Most of the commentaries r e l a t i n g to the new B i l l describe the non-resident c r e d i t o r s as being f o r e i g n parents of Canadian s u b s i d i a r i e s . Such a statement could be misleading, but i s probably the r e s u l t 113 of the f a c t s that the most obvious s i t u a t i o n s of t h i n c a p i t a l i z a t i o n a r i s e i n inter-company r e l a t i o n s h i p s and that s . 1 8 ( 4 ) ( a ) ( i i ) ( B ) r e f e r s to designated surplus, a concept used when one corporation takes over another. I t i s stressed that provisions p e n a l i z i n g t h i n c a p i t a l i z a t i o n a f f e c t non-resident i n d i v i d u a l shareholders,too. Any company r e s i d i n g i n Canada and having non-resident shareholders f a l l s w ithin such rules [s.18(5)(b)I.T.A.],except NROs, which are always denied the r i g h t to deduct the i n t e r e s t they pay out according to s.133(1)(a). The r e s t r i c t i o n has not been extended to t r u s t s , * . „ , 132a carry i n g on business i n Canada C. Disallowance f o r Interest Payment Deduction S.18(4)I.T.A. establishes which proportion of i n t e r e s t paid by the company to non-residents may not be deducted. This may be explained through a formula . If : A = greatest amount of outstanding debts to s p e c i f i e d non-residents i n the year; B = corporations paid-up c a p i t a l l i m i t (defined by s.89(l)(e) as the paid c a p i t a l minus the paid-up c a p i t a l d e f i c i e n c y ) ; C = tax-paid u n d i s t r i b u t e d surplus on hand at the beginning of the year; D = 1971 c a p i t a l surplus on hand; E = c a p i t a l dividend account [ s . 8 9 ( l ) ( b ) ] ; 114 F = amount which would be the designated surplus (see Part VII I.T.A.) i f the con t r o l of the company were acquired by another corporation; G = i n t e r e s t paid on outstanding debts to s p e c i f i e d non-residents i n the year then the proportion of i n t e r e s t paid to non-residents which i s not deductible by the company w i l l be equal to : A - [3 x (B +'C + D + E + F) ] x G A The outstanding debt i s constituted [S.18(4)] by a l l i n t e r e s t - b e a r i n g o b l i g a t i o n s owing by the company to s p e c i f i e d non-residents. The l i m i t a t i o n does not apply to non-interest-bearing debt, s p e c i a l l y not to interest-exempt current accounts between parents and s u b s i d i a r i e s Loans granted by persons who are not s p e c i f i e d non-residents are not taken i n t o account at a l l . As already mentioned, the l i m i t a t i o n a f f e c t s only that i n t e r e s t which i s r e l a t e d to debts owed to s p e c i f i e d non-residents i n accordance with an amendment of the new B i l l which before r e v i s i o n disallowed i n t e r e s t r e l a t e d to debts to any lenders. The sum of B+C+D+E+F represents the equity of a corporation. Roughly speaking, the company's equity for tax purposes can be obtained by 115 using tax values f o r assets and l i a b i l i t i e s (with some major accounting and f i s c a l adjustments) in. the computation of the corporation s net worth The formula of s.l8(4) was not immediately enforced i n conjunction with the other provisions of the new B i l l when i t was enacted on January 1,1972. In order to a l l e v i a t e the problems of t h i n l y c a p i t a l i z e d companies and to give them time to rearrange t h e i r f i n a n c i a l s t r u c t u r e , t r a n s i t i o n a l p r e s c r i p t i o n s permit the amount ca l c u l a t e d f o r the disallowance of i n t e r e s t expense to be reduced by a f i g u r e r e l a t e d to a company's "base year" (the tax year commencing before Junel9, 135 1971). For the two taxation years f o l l o w i n g the taxation year s t a r t i n g i n 1971 s.22(2) A p p l i c a t i o n Rules provides another formula to be combined with that of s.18(4)1.T.A.. The p r o v i s i o n of s.22(2) A p p l i c a t i o n Rules has been explained i n 13 very c l e a r terms i n one of the l a t e s t commentaries on the new Act I f : A = greatest amount of outstanding i n t e r e s t - b e a r i n g indebtedness to s p e c i f i e d non-residents during t r a n s i t i o n a l year; B = l a s t amount of outstanding i n t e r e s t - b e a r i n g indebtedness to s p e c i f i e d non-residents during base year; C = equity f o r the base year; D = equity f o r t r a n s i t i o n a l year; E = i n t e r e s t paid on outstanding i n t e r e s t - b e a r i n g indebtedness to s p e c i f i e d non-residents during t r a n s i t i o n a l year 116 then the disallowed proportion of i n t e r e s t paid to s p e c i f i e d non-residents w i l l be equal to : A - [B - (3 x C)] - (3 x D) x E 117 VII. CAPITAL GAINS 1. IN GENERAL Since 1917, when the f i r s t income tax l e g i s l a t i o n was enacted i n Canada, c a p i t a l gains were tax-free. The new tax law,however, makes such gains taxable — a most s i g n i f i c a n t and c o n t r o v e r s i a l innovation. This fundamental aspect of the new tax system a f f e c t s r esidents, non-residents who r e a l i z e c a p i t a l gains on d i s p o s i t i o n of c e r t a i n Canadian property, and persons who cease to be res i d e n t s . Taxation of c a p i t a l gains of non-residents w i l l f i g u r e s i g n i f i c a n t l y i n the t r e a t i e s ' renegotiation program of the government. The majority of present tax conventions between Canada and other countries provides that a person r e s i d i n g i n one treaty country and disposing of property i n another treaty country s h a l l be subject to c a p i t a l gain taxation of the country i n which he resides i f the 136 person r e a l i z i n g the c a p i t a l gain has no permanent establishment i n the country i n which he disposes of h i s assets. In other words, Canada has undertaken not to levy any tax on c a p i t a l gains r e a l i z e d i n Canada by residents of treaty countries. Such an undertaking previously posed no problem because Canada had no c a p i t a l gains taxation of any s o r t , but was nevertheless necessary i n order to ensure the tax exemption to Canadian residents obtaining gains when 118 s e l l i n g property i n countries that would otherwise have taxed them. In some t r e a t i e s , the exemption covers a l l gains derived from the s a l e or exchange of assets (e.g. Art VIII Canada-U.S. Reciprocal Tax Convention); i n other t r e a t i e s , the p r i v i l e g e i s l i m i t e d to c a p i t a l gains other than those from r e a l estate (e.g. Art.12 Canada -U.K. Income Tax Agreement). Although the new B i l l applies to non-residents the taxation of c a p i t a l gains, i t appears that such rules cannot be applied to non-residents who abide i n treaty countries unless the conventions are e i t h e r renegotiated or terminated. Another hypothesis does not seem probable at a l l . The f e d e r a l government has declared that i t intends to rev i s e the e x i s t i n g t r e a t i e s and to enter i n t o new agreements. The negotiation of new conventions and the amendment of those now i n force may prove d i f f i c u l t , and i f the government wants to achieve i t s purpose by 1976, as i t has sa i d , Canada w i l l have to make some concessions. These would c o n s i s t of the exempting of c a p i t a l gains (or some of them) made by non-residents i n Canada or accepting that Canadian residents are taxable i n other countries on the gains r e a l i z e d there. With respect to some t r e a t i e s , the p r i n c i p l e of taxing c a p i t a l gains w i l l probably be determined by residence (as provided now), except perhaps f o r r e a l estate and c a p i t a l assets e f f e c t i v e l y 137 connected with a permanent establishment i n Canada The general rules applying to the taxation of c a p i t a l gains of 119 non-residents are l a r g e l y the same as for residents; i t l i e s f a r beyond the purpose and l i m i t s of t h i s paper to analyse such tech- n i c a l d e t a i l s of the new l e g i s l a t i o n . It should be noted.however, that c a p i t a l gain ( c a p i t a l loss) means the gain (loss) from the d i s p o s i t i o n of any property other than e l i g i b l e c a p i t a l property, resource property, or l i f e insurance p o l i c i e s [s.39(1)I.T.A.]. The c a p i t a l gain i s a r r i v e d at by deducting from the proceeds of d i s p o s i t i o n (sale p r i c e , other compensation, insurance or expropriation proceeds) [s.54(h)I.T.A.] the adjusted cost base (defined i n s.54(a) and determined by s.53) and the expenses re l a t e d to the d i s p o s i t i o n [ s . 4 0 ( l ) ] . C a p i t a l gains are caught under taxing provisions not only when assets are e f f e c t i v e l y disposed of, but also i n various events that constitute 'deemed d i s p o s i t i o n s " ( d i s p o s i t i o n s by way of gift,changes i n the use of assets, and e s p e c i a l l y the death of taxpayers) [s.70(5)I.T.A ]. According to s.38, the taxable c a p i t a l gain i s one h a l f of the c a p i t a l gain and the allowable c a p i t a l l o s s , one h a l f of the c a p i t a l l o s s . Generally speaking, the allowable c a p i t a l losses f o r the year may be deducted from the taxable c a p i t a l gain [s.3(b)]. The net c a p i t a l gain so obtained i s included i n the taxpayer's income and taxed at his own rate. Thus the f i n a l r e s u l t i s the same as i n the United States where the f u l l net c a p i t a l gain i s imposed at a rate equal to the hal f of the taxpayer's one. Individuals are allowed to make a supplementary deduction of c a p i t a l losses up to 1,000 $ against t h e i r other income [ s . 3 ( e ) ( i i ) I . T . A . J . Net c a p i t a l losses may be c a r r i e d back one year and forward for an i n d e f i n i t e number of years up to t o t a l absorption [s.111(1)(b)] 120 unless the taxpayer i s a corporation whose con t r o l changes [ s . l l l ( 4 ) ] . I f the taxpayer d i e s , the whole of the unabsorbed net c a p i t a l l o s s may o f f s e t income from other sources [s.71 and 111(2)]. Properties g i v i n g r i s e to c a p i t a l gains have been separated i n t o d i f f e r e n t classes (personal use property, l i s t e d personal property) i n order to r e s t r i c t the d e d u c t i b i l i t y of c a p i t a l losses from c a p i t a l gains i n the same c l a s s , instead from c a p i t a l gains of any other c l a s s , and to e s t a b l i s h a minimum amount — $ 1,000— r e f e r r i n g to which c e r t a i n gains and losses w i l l be computed f o r tax purposes. 2. NON-RESIDENTS As mentioned, the new B i l l imposes tax on c e r t a i n c a p i t a l gains r e a l i z e d by non-residents. The f i r s t r u l e i s contained i n s.2(3)(c)I.T.A. which reads that non-residents who have disposed of a taxable Canadian property i n the year or i n a previous year w i l l pay an income tax i n Canada. The general p r o v i s i o n of s.3(b) states that only net taxable c a p i t a l gains — i . e . taxable c a p i t a l gains l e s s allowable c a p i t a l l o s s e s — are included i n the taxpayer's income; i t follows that non-residents w i l l s u f f e r the income tax only on net taxable c a p i t a l gains derived from d i s p o s i t i o n of taxable Canadian property. Just as non-residents holding employment or carrying on business i n Canada must £ile a tax return, so now must non-residents who dispose of taxable Canadian property, and t h e i r tax w i l l be c a l c u l a t e d 121 by reference to t h e i r own applicable tax bracket i f they are i n d i v i d u a l s or to the f i x e d corporate rate i f they are companies. If the non -residents have income from other sources, t h e i r taxable c a p i t a l gains w i l l be added to i t . A. Taxable Canadian Property The only taxable c a p i t a l gains of non-residents [ s . 1 1 5 ( 1 ) ( a ) ( i i i ) I.T.A.] are those from d i s p o s i t i o n of taxable Canadian property, a concept comprising a c e r t a i n number of property items l i s t e d i n s.115(1)(b)(i) to ( v i i i ) . A f t e r B i l l C-259 was given f i r s t reading i n Parliament, some minor amendments were made. The items of taxable Canadian property as amended are : - r e a l property i n Canada or i n t e r e s t s therein; - c a p i t a l property used i n c a r r y i n g on business i n Canada; - shares, or i n t e r e s t s i n shares, of corporations resident i n Canada other than public corporations; - shares, or i n t e r e s t s i n shares, of p u b l i c corporations i f at any time during the f i v e years preceding the d i s p o s i t i o n or the part of those years following 1971, the non-resident and/or r e l a t e d persons(i.e. those with whom he does not deal at arm's length) owned not l e s s than 25 % of the issued shares of any c l a s s of the c a p i t a l ; - an i n t e r e s t i n a partnership i f at any time i n the 12 months preceding the d i s p o s i t i o n or the part of those months a f t e r 1971, at l e a s t 50 % of the f a i r market value of the partnership property, 122 i n c l u d i n g the money at hand,consists of taxable Canadian property; - a c a p i t a l i n t e r e s t (defined by s.108(1)(c) as a be n e f i c i a r y ' s r i g h t to receive any part of the t r u s t ' s c a p i t a l ) i n a t r u s t resident i n Canada other than a un i t t r u s t ; - a unit i n u n i t t r u s t [S.108(2)] other than a mutual fund and r e s i d i n g i n Canada; - units of mutual fund t r u s t s (defined i n s.132(6)I.T.A.) i f at any time i n the f i v e years before the d i s p o s i t i o n of that part of those years a f t e r 1971, the non-resident taxpayer and/or r e l a t e d persons owned at l e a s t 25 % of the issued u n i t s . The notion of taxable Canadian property i s narrower than that of Canadian property; the l a t t e r i s defined nowhere i n the Act, but may be assumed to be anything that i s not a fo r e i g n property according to s.206(2). Such i s assumed i n the case of NROs, f o r which the concept of Canadian property [s.133(8) (b)] plays a s i g n i f i c a n t r o l e i n some p r o v i s i o n s . Non-taxable Canadian property t y p i c a l l y comprises p o r t f o l i o holdings of pu b l i c corporation shares or mutual fund t r u s t u n i t s , i f less than 25 % of the corporation or t r u s t and most of the Canadian debt s e c u r i t i e s (bonds, debentures, mortgages, hypotecs, e t c . ) . C a p i t a l gains which non-residents obtain on such Canadian property are not taxed i n Canada. This i s true p a r t i c u l a r l y i n the case of pu b l i c corporation shares which non-residents may dispose of without paying any a t t e n t i o n to tax consequences. For t h i s reason, non-resident shareholders w i l l favour the d i s t r i b u t i o n of dividends out of surpluses [s.83(l) I.T.A.]. The reduction of the adjusted cost basis of shares, normally 123 caused by such dividends, does not a f f e c t non-residents (Moreover, the same dividends are not taxable and not l i a b l e f o r withholding tax [s.212(2)]). When the c a p i t a l gains of the year are large, i n d i v i d u a l taxpayers are often i n t e r e s t e d i n spreading them over the years;for t h i s purpose, they may consider e i t h e r a general averaging or a forward averaging annuity. Non-residents, however, do not have such choice: the only device they can use i s the general averaging [s.H7(2); s.61]. If non-residents s u f f e r f o r e i g n taxes ( c a p i t a l gain or income) when disposing of t h e i r taxable Canadian property, they cannot claim any deduction against the tax payable i n Canada, f o r the fo r e i g n tax c r e d i t [s.126] i s a r e l i e f e x c l u s i v e l y granted to residents. F i n a l l y , s.40(2)(a) expressely denies to non-residents the reasonable reserve that s.40(l) allows for an amount not yet received from the sale of assets (deferred c a p i t a l gains). B. Enforcement of Tax The l e g i s l a t u r e has paid p a r t i c u l a r a t t e n t i o n to the means by which the avoidance of c a p i t a l gains tax owed by non-residents may be prevented. To t h i s end, i t has enacted provisions s e t t i n g up a system of "compliance c e r t i f i c a t e s " f o r the purpose of ensuring tax c o l l e c t i o n . There are two types of c e r t i f i c a t e s : one must be requested of the Department by the non-resident, the other i s 124 o p t i o n a l and depends on the non-resident taxpayer's choice. The system i s so organized that a purchaser —presumably a resident,but perhaps a n o n - r e s i d e n t — r i s k s s u f f e r i n g an ultimate l i a b i l i t y , i f the non-resident vendor f a i l s to comply with l e g i s l a t i o n regarding those c e r t i f i c a t e s . Before the d i s p o s i t i o n A non-resident who intends to dispose of h i s taxable Canadian property, except shares of pu b l i c corporations and mutual fund t r u s t u n i t s , may inform the Mi n i s t e r of Finance of the i d e n t i t y of the purchaser, the property to be so l d , the estimated proceeds, and the asset's adjusted cost base (the r e s u l t being the expected c a p i t a l gain)[s.116(1)]. There i s no o b l i g a t i o n to follow t h i s procedure. A f t e r paying Revenue 25 % of the foreseen c a p i t a l gain ( i . e . 50 % of the taxable gain) or fu r n i s h i n g an acceptable s e c u r i t y the non-resident vendor and the proposed purchaser w i l l be issued a c e r t i f i c a t e s e t t i n g f o r t h the amount of the estimated proceeds ( " c e r t i f i c a t e l imit")[s.116(2)I.T.A.]. If the d i s p o s i t i o n conforms to a l l clauses i n the c e r t i f i c a t e , no further step has to be taken u n t i l the moment when the taxpayer has to f i l e h i s ye a r l y tax return. A f t e r the d i s p o s i t i o n The vendor may also dispose of his taxable Canadian property without applying for a c e r t i f i c a t e p r i o r to the transaction. A f t e r 125 disposing of such property — s a v e p u b l i c corporations shares and mutual fund t r u s t u n i t s — the non-resident s h a l l within ten days inform the Department about the purchaser, the property, the p r i c e a c t u a l l y paid by the buyer and the adjusted cost base of the trans- ferred asset [s.116(3)1.T.A.]. Such a p o s t - d i s p o s i t i o n notice i s requited by the statute also i n the event that a compliance c e r t i f i c a t e was granted before and,later, a m o d i f i c a t i o n as to the purchaser or as to the a c t u a l gain took place. Upon payment of 25 % of the a c t u a l c a p i t a l gain or upon lodging acceptable s e c u r i t y by the non-resident, both p a r t i e s to the trans- a c t i o n w i l l be given a c e r t i f i c a t e concerning the dispositions.116 ( 4 ) ] . I f the vendor f a i l s to comply with s.116(3) and does not therefore send the prescribed notice, he i s g u i l t y of an offence and can be f i n e d between $ 200 and $ 10,000 , or both fin e d and j a i l e d up to s i x months [s.238(2)]. Purchaser l i a b i l i t y According to s,116(5) the purchaser i s l i a b l e to pay the Revenue on behalf of the vendor 15 % of the excess of the p r i c e he has paid over the " c e r t i f i c a t e l i m i t " f i x e d i n the pre-sale c e r t i f i c a t e , i f any. It seems that i f the vendor has not previously asked f o r any optional c e r t i f i c a t e , the purchaser must remit to the taxation authority 15 % 13 8 of the f u l l p r i c e , as the c e r t i f i c a t e l i m i t would be n i l . The 126 statute does not order the purchaser to r e t a i n the 15 % amount on the p r i c e ; i t simply reads that he i s e n t i t l e d to withhold i t or to otherwise recover i t from the vendor. The purchaser could encounter d i f f i c u l t i e s when he attempts to recover the amount he has paid on behalf of the non-resident; thus use of the withholding system w i l l l i k e l y prove more frequent. A f t e r the Mi n i s t e r has issued the post-sale c e r t i f i c a t e , the purchaser ceases to be responsible. The l i a b i l i t y of the purchaser was reduced somewhat subsequent to the f i r s t reading of the new B i l l . When the vendor's status as a resident or non-resident i s unknown, the purchaser i s not n e c e s s a r i l y l i a b l e . The duty of the purchaser i s that of making reasonable i n q u i r i e s as to the vendor's status; i f a f t e r i n q u i r i n g , he has no reason to believe that the vendor does not reside i n Canada, he i s no longer l i a b l e . The notion of "reasonable i n q u i r y " i s undefined and w i l l probably remain so u n t i l the matter comes before j u d i c i a l a u t h ority. As the purchaser i s nowhere i n the Act defined as a resident, the l i a b i l i t y created by s.116(5) presumably extends to everybody, whether or not resident, to whom a non-resident disposes of taxable Canadian property-*--*? 3. EMIGRANTS The l e g i s l a t u r e has also enacted provisions concerning those taxpayers who leave Canada without disposing of t h e i r property, the provisions are intended to prevent such persons from escaping taxation of 7 127 c a p i t a l gains. A. Deemed D i s p o s i t i o n According to s.48(1)1.T.A., taxpayers who cease to be residents i n Canada are deemed to have disposed of t h e i r property — o t h e r than taxable Canadian property, or ri g h t s to receive pensions, or deferred p r o f i t s , or annuities payments— at a p r i c e equal to i t s f a i r market value at time of departure. The p r o v i s i o n does not apply to taxable Canadian property, f o r c a p i t a l gains on i t s d i s p o s i t i o n are always taxed whether or not the owner has become a non-resident, because non-residents s u f f e r the taxation of gains obtained from such property [ s . 1 1 5 ( 1 ) ( a ) ( i i i ) and (b ) ] . I f the taxpayer has emigrated to a country which i s bound to Canada by a treaty l i m i t i n g or excluding the taxation of c a p i t a l gains, the tax on gains from d i s p o s i t i o n of taxable Canadian property w i l l not be imposed, e i t h e r e n t i r e l y or i n part. Nor does the pr o v i s i o n concern r i g h t s to payments r e c e i v a b l e from pension plans,registered retirement saving plans, p r o f i t sharing plans, or annuity contracts, because such payments to non-residents are subject to the withholding tax [s.212(1)(h) to ( o ) ] . Any other property i s deemed to have been disposed of for proceeds amounting to the f a i r market value. The c a p i t a l gain i s determined by substracting the adjusted cost base from the f a i r market value. One h a l f of the r e s u l t of the preceding c a l c u l a t i o n equals the taxable 128 c a p i t a l gain which i s included i n the taxpayer's income. If the. taxpayer i s an i n d i v i d u a l other than a tru s t , o n l y the taxable gains i n excess of $ 2,500 ( i . e . gains i n excess of $ 5,000) are taken into h i s income [ s . 4 8 ( l ) ] . The same p r o v i s i o n provides that a f t e r the deemed d i s p o s i t i o n , taxpayers who cease to be residents i n Canada are considered to have immediately reacquired t h e i r property at a cost equivalent to the same f a i r market value. I t i s d i f f i c u l t to understand what the l e g i s l a t u r e intended by t h i s r u l e , f o r i t seems to be immaterial to the tax law. In f a c t i f emigrant taxpayers do not come back to Canada, such property w i l l no longer be considered f o r Canadian tax purposes; i f they come again to Canada, they f a l l w i t h i n the r u l e covering those who become re s i d e n t s . The j u s t i f i c a t i o n given by the government f o r taxation of such deemed c a p i t a l gains i s that i t i s f a i r to assess them because they accrued to the taxpayers while they shared the advantages of l i v i n g i n Canada I t i s not clear at a l l whether s.48(l) covers only c a p i t a l property, which comprises depreciable property, and property whose c a p i t a l gains are taxable [s.54(b)I.T.A.], or any property other than those excluded; t h i s aspect of the law has evoked two commentaries. The f i r s t and apparently more l o g i c a l commentary contends that s.48(l) only r e l a t e s to c a p i t a l property because the r u l e i s stated 129 for the purposes of Division B/subdivision c which deals with 141 taxable capital gains and allowable capital losses . The other commentary argues that the deemed disposition rule applies to any property other than specifically excluded, the argument being based on a comparison with s.69(l)(b) which reads that a person who makes an inter vivos g i f t of anything, capital property or otherwise, is considered to have received "price" equivalent to 142 the f a i r market value and therefore to have realized a capital gain B. Deferral Election If the taxpayer, especially an individual, ceases to be resident only for a certain number of years and afterwards becomes again a resident of Canada, then the deemed disposition rule may lead to some excessive hardship. The new B i l l , therefore, provides a r e l i e f measure granting to some taxpayers the opportunity to "defer" capital gains to that time when property is actually disposed of. According to s.48(2), this choice is offered only to individuals other than trusts, and companies qualifying as Canadian corporations [ 8 . 8 9 ( 1 ) ( a ) ] . To benefit from the election one has to furnish acceptable security which may consist of a charge on the property of the taxpayer or of a third person, or of a guarantee from other persons. If a taxpayer who has made a deferral election leaves Canada the taxpayer i s not considered to have disposed of his property 130 other than that excluded by s.48(l) but he i s deemed to be a resident throughout the year i n which he disposes of the property. Consequently, f o r that taxation year,the taxpayer i s taxable i n Canada not only on h i s taxable gains from the d i s p o s i t i o n of property, but i n compliance with s.3 I.T.A., on h i s t o t a l world income. Where the Canadian rates are higher than those of the country of residence, the taxpayer w i l l s u f f e r supplementary income tax, although he may deduct from Canadian tax the f o r e i g n tax he has paid [s.126]. Thus d e f e r r a l e l e c t i o n implies more than 143 a simple d e f e r r a l of tax . The taxpayer w i l l be treated as a resident i n the d i s p o s i t i o n year except for the purpose of tax-free mortis causa [s.70(6)I.T.A.] or i n t e r vivos [s.73(1)1.T.A.] tran s f e r s or d i s t r i b u t i o n s to a spouse or exclusive spouse's t r u s t , as w e l l as f o r s p e c i a l exceptional reserves [s.72(2)] i n the year of death [s.48(2)(d)]. I t i s noteworthy that the p r o v i s i o n only applies when the actual d i s p o s i t i o n brings a c a p i t a l gain; i t would be unduly harsh i f the emigrants were required to s u f f e r Canadian tax on t h e i r f o r e i g n income because of a d i s p o s i t i o n causing them a c a p i t a l l o s s . Individuals e l e c t i n g the a l t e r n a t i v e to d e f e r r a l e l e c t i o n w i l l probably be emigrants who intend to come back to Canada s h o r t l y a f t e r leaving and who do not s e l l t h e i r property. Those emigrants who do not plan to return are more a t t r a c t e d to the $ 2,500 exemption granted by s . 4 8 ( l ) . For companies, opportunities to use the e l e c t i o n are extremely 3 131 restricted by the law, for such companies must be Canadian corporations which are able to give up their residence in this country. Considering the definition of residence [case-law and s.250(4)I.T.A.] and of Canadian corporation [s.89(1)(a)J, i t appears that the election is open to corporations incorporated outside Canada and continuously 144 resident in Canada since June 18,1971 4. D1MIGRANTS S.48(3) provides that persons becoming residents of Canada are deemed to have acquired the property they own at that time at a cost equal to f a i r market value at the moment they establish residence in Canada. Two classes of property are excluded : property for which a deferral election has been made under s.48(2) and property that would be taxable Canadian property. Without this restriction, non-residents could escape taxation of capital gains by taking up residence in Canada shortly before the proposed disposition and by having the gains computed by reference to a cost equivalent to the practice made possible by s.48(3). 132 VIII. CONCLUSION The p a r t i c u l a r innovations which the new Income Tax Act brings to the taxation of non-resident i n d i v i d u a l s and corporations are perhaps l e s s revolutionary and confusing than some other aspects of the new law. As regards non-residents, the three main changes seem to be taxation on c a p i t a l gains, new treatment of non-resident -owned investment corporations, and p r o h i b i t i o n of t h i n c a p i t a - l i z a t i o n . These are major changes a f f e c t i n g e s s e n t i a l p r i n c i p l e s of the e n t i r e system of taxation of non-residents. With respect to taxation of c a p i t a l gains r e a l i z e d by non-resident persons, i t may be observed that, i n f a c t , i t simply i s an aspect of a basic m o d i f i c a t i o n of the a t t i t u d e which previously held a l l c a p i t a l gains to be non-taxable. Beside these major innovations, there are a number of other changes. Some of them, l e s s evident than those above, t h e o r e t i c a l l y may have great consequences; f o r example, the imposition of a tax on discount on bonds, or the termination of the b e n e f i t of a dividend tax c r e d i t to resident i n d i v i d u a l s p a r t i c i p a t i n g e i t h e r i n resident companies which are not Canadian corporations or i n non-resident corporations doing business i n Canada . Other modifications comprise merely t e c h n i c a l modifications, such as the increase i n the withholding and a d d i t i o n a l tax rates or the supplementary requirements for payment of tax-exempt i n t e r e s t . 133 Non-residents are not only a f f e c t e d by changes i n provisions concerning t h e i r tax treatment: the tax burden they s u f f e r also depends upon taxation of residents, e s p e c i a l l y of Canadian companies i n which they are i n t e r e s t e d . Rules such as those i n v o l v i n g corporate d i s t r i b u t i o n s , small business incentive f o r private corporations, and foreign accrual property income, w i l l c e r t a i n l y have repercussions on the tax impact which non-residents f e e l . In a few years, the i n t e r n a t i o n a l r a m ifications of the intra-Canadian tax provisions w i l l be better known, and i t w i l l then become possible to study t h e i r consequences on non-residents. Some of the provisions taxing non-resident persons w i l l be modified by double taxation t r e a t i e s which Canada w i l l renegotiate or by new conventions. Therefore, one must be extremely cautious when tr y i n g to foresee the e f f e c t s of tax l e g i s l a t i o n which can be superseded i n part by i n t e r n a t i o n a l t r e a t i e s . For example, f i s c a l conventions may grant exemptions and tax reductions or make t a x a b i l i t y dependent upon p a r t i c u l a r q u a l i f i c a t i o n s . Canadian c i t i z e n s worried about fo r e i g n ownership and c o n t r o l of Canadian economic structures would welcome l e g i s l a t i o n discouraging f o r e i g n investments by taxing them heavily, but those Canadian w i l l be disappointed because the new Act does not discourage non-residents from operating business or i n v e s t i n g i n Canada. Other Canadians believe that Canada should be as open as possible 3 134 to f o r e i g n investments i n order to finance i t s economic development and i n d u s t r i a l a c t i v i t i e s . For them, the new Act probably taxes too h e a v i l y non-resident investments. Non-residents c o n t r o l l i n g corporations resident i n Canada s u f f e r an e s p e c i a l l y heavy tax burden : a corporate tax of 50 % and a withholding tax of 25 %, without -of course- any dividend tax c r e d i t . More moderate and r e a l i s t i c i n i t s views than the opponents and proponents of f o r e i g n investment i n Canada, the Carter Commission stated that Canada needs an inflow of fo r e i g n c a p i t a l , to support 145 i t s economic growth . But the commission also recognized the necessity to counterbalance f o r e i g n influence i n some f i e l d s by encouraging Canadian residents to devote t h e i r f i n a n c i a l resources to d i r e c t investment i n Canada^*? The Carter Commission suggests three ways to achieve t h i s goal. F i r s t , withholding tax rate should be increased to 30 %, the p o s s i b i l i t y of reduction by treaty being always open. The increase i n the withholding tax rate should not be applied to dividends 1^*? To j u s t i f y t h i s r e s t r i c t i o n on the a p p l i c a t i o n of the rate increase to dividends, Carter i n s i s t s that the proposals of i n t e g r a t i o n of corporations and resident shareholders would co n s t i t u t e a s u f f i c i e n t incentive to induce Canadians to acquire more equity i n resident corporations. The Carter Commission r e s t r i c t s the i n t e g r a t i o n proposals to residents, so that the residents would be better able 148 to compete against f o r e i g n shareholders . No increase i n the withholding tax on dividends, therefore, would be required. 135 Second,the commission suggests that measures be taken to prevent t h i n c a p i t a l i z a t i o n of companies i n which non-residents are i n t e r e s t e d . The s u b s t i t u t i o n by non-residents of lending money fo r purchasing equity i s a t y p i c a l form of tax avoidance and as 149 such must be fought Third, the commission recommends a b o l i t i o n of the concept of the non-resident-owned investment corporation, an i n s t i t u t i o n a l i z e d tax-haven opportunity,not serving the true i n t e r e s t of Canada1"*? The recommandations of the Carter Commission have been only p a r t i a l l y implemented i n the new tax l e g i s l a t i o n . F i r s t , the withholding tax rate has been increased only to 25 %, e f f e c t i v e since 1976. The increase i s 5 % less than the Carter Commission suggested. By so doing Canada may have remained s l i g h t l y more a t t r a c t i v e to some investors than the United States where the corresponding tax amounts to 30 %, unless modified by s p e c i a l t r e a t y . The increase to 25 % also extends to dividends flowing from Canadian companies to non-resident shareholders. With the exception of the small business incentive,the Carter Commission's proposals of i n t e g r a t i o n are not enacted by the statute. Instead of g i v i n g residents a competitive advantage i n acquiring Canadian equity, the new law, by r a i s i n g withholding tax may discourage non-residents otherwise a t t r a c t e d to the a c q u i s i t i o n of shares i n Canadian-based companies. Second, t h i n c a p i t a l i z a t i o n has been penalized by preventing 136 companies from deducting,under c e r t a i n circumstances, i n t e r e s t payments. Third,the non-resident-owned investment corporation has not been abolished, but important changes have been introduced i n t o the law. Apart from increasing the corporate tax rate, dividends to shareholders are now subject to withholding tax. The company w i l l obtain a refund of tax previously paid upon d i s t r i b u t i o n of dividends. Probably, l e g i s l a t u r e does not consider such companies to be a threat to the e f f e c t i v e n e s s and i n t e g r i t y of the tax system. A l a s t , b r i e f observation may be made about taxation of c a p i t a l gains. The new r u l e , which requires the i n c l u s i o n of one h a l f of the gain i n income, concerns residents as w e l l as non-residents. The l a t t e r are taxed only i f the assets they have disposed of are c l a s s i f i e d as taxable Canadian property. This fundamental innovation w i l l r a i s e complex problems i n the area of taxation of non-residents, e s p e c i a l l y because the new statutory provisions openly c o n f l i c t with most of the e x i s t i n g t r e a t i e s , which exempt non-residents from tax on c a p i t a l gains. The question of deciding whether statute or conventions w i l l p r e v a i l i s d e l i c a t e and involves both c o n s t i t u t i o n a l and i n t e r n a t i o n a l public law. Apart from the l e g a l aspect, i t w i l l be important to a s c e r t a i n the ultimate e f f e c t of the c a p i t a l gains tax on non-residents. I t w i l l be p o s s i b l e , to a c e r t a i n extent, to see whether non-residents have previously invested i n Canada, p r i n c i p a l l y because they have been a t t r a c t e d by the opportunity to obtain tax-free gains. I t w i l l 137 appear whether some investors desert Canada, considering i t less attractive. That i s a question that only the next years w i l l answer. 3 138 FOOT - NOTES I. Chapter 1. Foreign Ownership and the structure of Canadian Industry Report of the TASK FORCE headed by Prof. M.H. WATKINS January 1968, pp. 5-13 l a "Carter on the taxation of i n t e r n a t i o n a l income flow ' MIESZKOWSKI - 1969 (22) National Tax Journal p.97 l b "International Aspects I of the White Paper on Proposals f o r Tax Reform" A. SHORT - 1970 Conference Report of the Canadian Tax Foundation p.171 2. Countries with which Canada has income tax conventions : United States of America France United Kingdom West Germany A u s t r a l i a Danemark. New Zealand Sweden Union of South A f r i c a Norway Japon Finland T r i n i d a d Belgium I s r a e l Netherlands I I . Chapter 3. " L i a b i l i t y for tax = Residence, Domicile, C i t i z e n s h i p ?" SHERBANIUK - 1963 Conference Report of the Canadian Tax Foundation, p.315 4. 1928 AC 217 4a 1928 AC 234 5. 2 (1946) DTC 812 6. 1949 DTC 536 7. 4(1950) DTC 232 (T.A.B.) 8. 5(1904) TC 101 139 9. 1950 DTC 437 10. 1952 DTC 1183 11. 1971 DTC 232 12. 1971 DTC 39 13. 1957 DTC 230 14. 1962 DTC 1225 14a The P r i n c i p l e s of Canadian Income Taxation F.E. laBRIE, CCH 1965, p.16 15. "Income Tax Residence Rules" KOERNER - 1961 Conference Report of the Canadian Tax Foundation, p. 235 16. 1969 DTC 503 17. 1969 DTC 754 18. see notes 13 and 14 19. 1906 AC 455 20. 1929 AC 1 21. 1925 AC 495 22. (1941) 64 CLR 241 23. (1952) 1 A l l ER 646 24. 1969 DTC 5051 (Ex. C) 25. 1960 AC 357 26. 1961 DTC 716 (T.A.B.) 27. 1970 DTC 6072 see also Zehnder & Company v. M.N.R. - 1970 DTC 6064 28. 1970 DTC 6370 (Ex. C), now under appeal 29. 2(1945) DTC 692 (Ex.C) ; 2(1946) DTC 824 (S.C.C.) , 2(1946) DTC 839 (P.C.) 3 140 30. 1971 DTC 5186 (Ex. C) , now under appeal I I I . Chapter 31. (1880) 15 Ch. D. 247 32. (1884) 53 L J Ch. 99 33. 2(1943) DTC 610 (Ex. C) 34. 1881/82 QB 414 35. 1896 AC 325 36. 1942 SCR 476 37. (1922) 1 AC 417 38. 13 (1928) TC 539 39. 1961 DTC 1099 40. "Carrying on business i n Canada" KEYES - 1962 Canadian Tax Journal, p.41 41. 1967 DTC 175 (T.A.B.), now under appeal 42. 1969 DTC 127 (T.A.B.) 43. 1970 DTC 6370 43a 1971 DTC 131 (T.A.B.), now under appeal 43b I t may be worthy of notice that s.255 I.T.A. reads that the expression " i n Canada" so frequently repeated i n t h i s chapter includes the sea bed and s u b s o i l of the submarine areas adjacent to the Canadian coasts i n respect of which exploring and d r i l l i n g r i g h t s or l i c e n s e s are issued by the f e d e r a l or p r o v i n c i a l governments 44. (1893) 1 QB 326 45. 4(1898) TC 25 46. 1925 KB 30 47. see note 38 48. (1914) 6 WWR 939 49. Keyes, l o c . c i t . 141 50. LaBrie, op. c i t . p.21 51. (1933) 2 DLR 85 (SCC) 52. 1936/37 Ex CR 71 53. see note 36 54. see note 50 55. 1967 DTC 421 56. see note 41 57. see note 42 58. see note 43a 59. see note 39 60. 1952 DTC 202 61. "Investment i n r e a l estate i n Canada by non-residents" SILVER - 1968 Conference Report of the Canadian Tax Foundation, p.177 62. "Tax Problems for United Kingdom Companies doing business i n Canada" Prof. J.M. Maclntyre - 1968 B r i t i s h Tax Review, p. 306 63. see note 60 64. 1964 DTC 194 (T.A.B.) 65. 1962 DTC 100 (T.A.B.) 66. see notes 42 and 58 67. Analysis of the Canadian Tax Reform B i l l 1971 CCH, September 1971, p.265 68. LaBrie, op. c i t . p.616 69. Tomorrow's Taxes Canadian I n s t i t u t e of Chartered Accountants, September 1971,p.29 70. see note 55 71. see note 65 142 71a Maclntyre, l o c . c i t . 71b 1966 DTC 5358 (Ex. C) ; 1968 DTC 5033 (S.C.C.) 72. LaBrie, op. c i t . p.468 73. LaBrie, op. c i t . p.435 74. A wide d e f i n i t i o n was given i n s.400(2)old Income Tax Regulations; several p a r t i c u l a r cases were enumerated therein. See also s.2600(2) for i n d i v i d u a l s 74a e.g. Ontario : s . l . ( l ) ( 1 8 ) of the Income Tax Act. 1961-62, Ontario Statutes 1961-62, c.60 r e f e r r i n g to the f e d e r a l regulations 74b E.g.: — s . 3 ( f ) of Protocol to 1942 Canadian-United States Tax Convention: 'the term"permanent establishment" includes branches, mines and o i l wells, farms, timber land, p l a n t a t i o n s , f a c t o r i e s , workshops, warehouses, o f f i c e s , agencies and other f i x e d places of business of an e n t e r p r i s e . . . " — a r t . 4 of 1966 Canadian-United Kingdom Tax Agreements: "the term"permanent establishment" means a f i x e d place of business i n which the business of the enterprise i s wholly or p a r t l y c a r r i e d on and s h a l l include e s p e c i a l l y a place of management; a branch; an o f f i c e ; a f a c t o r y ; a workshop; a mine, quarry or other place of e x t r a c t i o n of natural resources; a b u i l d i n g s i t e or construction or assembly project which e x i s t s f o r more than 12 months...." 75. "U.S. Business Operations i n Canada" SILVER - 1966 Canadian Tax Journal, p.368 76. Maclntyre, l o c . c i t . 77. "Taxation of U.S. Private Investments i n Canada" WILLIAMSON - (1963) Canadian Tax Paper n.36, p.89 78. S i l v e r , l o c . c i t . at note 75 79. Maclntyre, l o c . c i t . 80. Williamson, op. c i t . 81. CCH A n a l y s i s , p.270 82. Summary of 1971 Tax Reform L e g i s l a t i o n The Honourable E.J. Benson, M i n i s t e r of Finance, p.58 83. 1966 DTC 130 (TAB) 143 84. see note 71b IV Chapter 85. see e.g., National Trust Co. Ltd., Trustee of Sam Gorman v. M.N.R. 1954 DTC 33 (TAB) 85a LaBrie, op. cit.p.620 86. Williamson, op. c i t . 87. CCH Analysis,p.267 88. M.J. Walsh Ltd. v. M.N.R., 1955 DTC 593 (TAB) 89. 1971 DTC 5235, now under appeal 90. 1966 DTC 5001 (Ex.C) 91. CCH Ana l y s i s , p.267 92. Tomorrow's Taxes, p.239 93. "Withholding on income of non-residents" D.McGURRAN - 1960 Canadian Tax Journal p.61 94. J a v e l i n Foundries & Machine Work Ltd. v. M.N.R., 1967 DTC 392 (TAB) 95. P.R. Pearson, Trustee i n Bankruptcy .for William P i t t Hotel Ltd. v. M.N.R., 1964 DTC 224 (TAB) 96. 1 (1938) DTC 424 96a s.213(2) extends the exemption to the shareholders of a company holding shares i n a fo r e i g n business corporation and operating public u t i l i t i e s i n the shareholders 1 country through the intermediary l a t t e r corporation. 97. see, for attempt of examining these t e c h n i c a l provisions under the old Act: "Foreign Ownership - Canadian P r o v i s i o n " S.D. THOM - (1964) Canadian Tax Paper n.38, p.31 93. 1967 DTC 5289; 1968 DTC 5220 99. S i l v e r , l o c . c i t . a t . 61 100. 1969 DTC 5142 ; 1970 DTC 6271 (S.C.C.) 144 101. McGurran , l o c . c i t . 102. 1962 DTC 247 103. 1962 TR 9 (H.L.) 104. B.K. Sanden (at the Conference) see also "Parent-Subsidiary Know-how Charges (Inter-Company Transactions)" B. K. SANDEN - (1964) Canadian Tax Paper n.38 105. "Know-how and Withholding" A. SHORT - 1964 Canadian Tax Journal, p.354 106. 1964 TR 129 (H.L.) see also Commissioners v. United A i r c r a f t Corp. (1943) 68 C. L.R. 525 (H.C. of A u s t r a l i a ) 107. I.R.C. v. Desoutter Brothers L t d . (1946) 1 A l l ER 261 Tootal Broadhurst Lee Co. Ltd. v. I.R.C. (1949) 1 A l l ER 261 108. 1964 DTC 428 109. Short, l o c . c i t . at note 105 110. 37 (1957) TC 54 (H.L.) 111. 1969 DTC 5204 111a see also "Technical Service Fees are R o y a l t i e s " STIKEMANN - A p r i l 1971 n.162 Canada Tax Service L e t t e r 112. 1967 DTC 5303 113. Madntyre , l o c . c i t . 114. 1962 DTC 1338 115. "The management fees tax" A. SHORT - 1963 Canadian Tax Journal, p.324 116. "International inter-company payments for s e r v i c e s " A. SHORT - 1965 Canadian Tax Journal, p.113 117. see note 108 118. House of Common Debates, July 22,1963 p.2487, Gordon 119. "Management or Administration Fee or Charge" STIKEMANN, January 1964 n.84 Canada Tax Service L e t t e r 145 120. Short, l o c . c i t . at note 116 121. Maclntyre , l o c . c i t . 122. see note 39 123. see note 85 V. Chapter 124. "The future Use of NROs" January 1972 n.177 Canada Tax L e t t e r 124a 1955 DTC 386 125. 1958 DTC 9 (TAB) 126. see note 124 127. 1961 DTC 702 (TAB) ; 1963 DTC 1149 (Ex. C) 128. "Tax Reform - International Income" TOUCH ROSS & Cd - January 1972 - p.33 128a so defined "Canadian property" i s a larger concept than "taxable Canadian property"; e.g. bonds or other o b l i g a t i o n s issued i n Canada, shares of pub l i c corporations amounting to less than 25 % of the issued shares, u n i t of mutual fund t r u s t s amounting to l e s s than 25 % of the issued u n i t s c o n s t i t u t e Canadian property [s.133(8)(b) and 206(2)I.T.A.] without being taxable Canadian property, s.115(1)(b) 129. the assumption i s i n compliance with s.134 I.T.A., which reads that an NRO may not be deemed to be a Canadian or a p r i v a t e corporation save f o r the purpose of s.83(1)1.T.A. 130. see note 124 131. see note 124 VI. Chapter 132. Report of the Royal Commission on Taxation,Vol. 4 International Aspects of Income Taxation, p.549 "Adoption of the recommandation, that c e r t a i n payments of in t e r e s t by a subsidiary to a non-resident parent company should be deemed to be dividend, and therefore not be deductible, 146 would reduce the number of instances where manipulation between these types of payments could occur." 132a Tomorrow's Taxes, p.231 133. CCH A n a l y s i s , p.272 134. Tomorrow's Taxes, p.232 135. Touch Ross & Co, op. c i t . p.36 135a see CCH -"Explanation of Canadian Tax Reform"February 1972, pp.343-44 VII Chapter 136. see note 74 137. CCH Explanation,p.76 138. Tomorrow's Taxes, p.233 139. CCH Explanation,p.75 140. Summary,p.34 141. CCH Explanation,p.71 142. " G i f t s and Bequests, Emigrants and Immigrants and Residents" W.D. GOODMAN - Canadian Bar Papers on Tax Reform 1971,p.152 143. CCH Explanation,?.72 144. i n f a c t even s.48(l) may only concern companies incorporated i n a country other than Canada, for i f they are incorporated i n Canada ( p a r t i c u l a r l y a f t e r A p r i l 1965) they go on r e s i d i n g here no matter where the c e n t r a l c o n t r o l and management i s located. VIII.Chapter 145. Report of the Royal Commission on Taxation (Carter) Vol.2, c.5 International Economic Aspects, p.211 146. ibid,p.213 147. ibid,Vol.4,c.26 International Aspects of Income Taxation,p.488 147 148. i b i d . , p.483 149. i b i d . , Vol.4, c.19 Corporations, p.74 150. i b i d . , Vol.4, c.26, p.577 148 B I B L I O G R A P H Y BOOKS Honourable BENSON - "Summary of 1971 Tax Reform L e g i s l a t i o n " CANADIAN BAR ASSOCIATION - "Bri e f on Tax Reform B i l l C-259" - 1971 (Aug.20) CANADIAN INSTITUTE OF CHARTERED ACCOUNTANTS - "Discussion on B i l l C-259" 1971 (Aug. 27) CANADIAN INSTITUTE OF CHARTERED ACCOUNTANTS - ''Tomorrow's Taxes" 1971 (Sept.) CCH - "Analysis of the Canadian Tax Reform B i l l 1971" - 1971 (Sept.) CCH - "Explanation of Canadian Tax Reform" - 1972 (Febr.) CCH - "Canadian Master Tax Guide" - 1971 GILMOUR - "Income Tax Handbook." - 1971, 21st Ed. de l a GIRODAY - "Canadian Taxation and Foreign Investment" Canadian Tax Papers n.9, 1955 LaBRIE - "The P r i n c i p l e of Canadian Income Taxation"- CCH, 1965 J.G. McDONALD - "Cases and Materials on Income Tax" - 1963 (2nd Ed.) ROYAL COMMISSION (Chairmanship of Mr. K.L.Carter) - "Report on Taxation" - 1966 TASK FORCE (headed by Prof. Watkins) - "Report on Foreign Ownership and the Structure of Canadian Industry" - 1968 TOUCH ROSS & Co. - "Tax Reform - C a p i t a l Gains" - Sept. 1971 - "Tax Reform - Int e r n a t i o n a l Income" - January 1972 WILLIAMSON - "Taxation of U.S. Private Investments i n Canada" Canadian Tax Papers n. 36 - 1963 Takes Abroad Canadian Tax Foundation - Western Germany - 1958 - Belgium - 1959 - S w i t z e r l a n d - 1962 149 World Tax Series Harvard Law School - " I n t e r n a t i o n a l Program i n Taxation" NORR/DUFFY/STERNER -"Taxation i n Sweden"- 1959 GUMPEL(and Boettcher)-"Taxation i n the Federal Republic of Germany" - 1963 COBB(and Forte) -"Taxation i n I t a l y " - 1964 N0RR(and Kerlan) -"Taxation i n France" - 1966 ARTICLES BUTTERFIELD - "Bermuda-Atlantic Crossroads" - 1959 Canadian Tax Journal, p.301 CARON - "Investment Income of Private Corporations, Dividend Tax Credit and Foreign Corporations" • Canadian Bar Papers on Tax Reform 1971 - CCH 1971, p. 177 CUMYN - "European Business Operations i n Canada" I n v i t a t i o n a l Tax Reform Seminar - De Boo Ltd . 1971, p.68 FORD - "International Operations : Holding Companies" (1965 Corporate Management Conference) - Canadian Tax Papers n.41 1965, p.41 GOODMAN - " G i f t s and Bequests, Emigrants and Immigrants and Non-Residents" Canadian Bar Papers on Tax Reform 1971 - CCH 1971, p.141 INGLIS and BROWN - "The Road not taken : trends i n the r e l i e f of Corporate Double Taxation i n the U.K. and Canada" 1971 Canadian Tax Journal, p.259 JONES - "Inter-Company P r i c i n g : an enigma" - 1971 Canadian Tax Journal,p.438 KEYES - "Carrying on Business i n Canada" - 1962 Canadian Tax Journal, p.41 KOERNER - "Income Tax Residence Rules" 1961 Conference Report - Canadian Tax Foundation - p.235 LANVIN and WYATT •- "Concept of Permanent Establishment" Revue Juridique Themis de l ' U n i v e r s i t e de Montreal, n.2 - 1969 MacINTYRE - "Tax Problems f o r United Kingdom Companies Doing Business i n Canada" 1968 B r i t i s h Tax Review, p.306 McGURRAN - "Overseas Trade Corporations and Foreign Business Corporations" 1957 Canadian Tax Journal, p.323 McGURRAN - "Withholding on Income of Non-Residents" 1960 Canadian Tax Journal, p.61 MIESZKOWSKI - "Carter on the Taxation of I n t e r n a t i o n a l Income Flow" 1969(22) National Tax Journal, p.97 3 150 MONROE - "Canadian S u b s i d i a r i e s of U.S. Parent" I n v i t a t i o n a l Tax Reform Seminar - De Boo Ltd. 1971 - p.54 SANDEN - "Parent S u b s i d i a r i e s Know-how Charges (Inter-Company Transactions)" (1964 In t e r n a t i o n a l Corporate Tax Conference) Canadian Tax Papers n.36 - 1964, p.41 SHERBANIUK - " L i a b i l i t y f o r Tax - Residence, Domicile, C i t i z e n s h i p ? " 1963 Conference Report - Canadian Tax Foundation - p.315 SHORT - "The Management Fees Tax " - 1963 Canadian Tax Journal, p.324 SHORT - "Know-how and Withholding" - 1964 Canadian Tax Journal, p.354 SHORT - "International Inter-Company Payments f or Services" 1965 Canadian Tax Journal, p.113 SHORT - "International Aspect of the White Paper on Proposals f o r Tax Reform" 1970 Conference Report - Canadian Tax Foundation, p.171 SILVER - "U.S. Business Operations i n Canada" 1966 Canadian Tax Journal, p.368 SILVER - "Investment i n Real Estate i n Canada by Non-Residents" 1968 Conference Report - Canadian Tax Foundation, p.177 SILVERSTEIN - "Tax Havens and Tax T r e a t i e s " I n v i t a t i o n a l Tax Reform Seminar - De Boo Ltd. 1971,p.63 SMITH - "What p r i c e Residence" - 1961 Canadian Tax Journal,p.381 SMITH - "Dividend Income; C a p i t a l Gains; D i s t r i b u t i o n s of Corporate Surpluses; Corporate Reorganizations" Canadian Bar Papers on Tax Reform 1971 - CCH 1971,p.167 STIKEMAN - "The M u l t i n a t i o n a l Corporation and the New System" I n v i t a t i o n a l Tax Reform Seminar - De Boo Ltd. 1971,p.21 TAMAKI - "Sale o f Know-how" - (1963 Corporate Management Conference)- Canadian Tax Papers n. 34, 1963,p.41 THOM - "Foreign Ownership - Canadian P r o v i s i o n " (1964 International Corporate Tax Conference) Canadian Tax Papers n.38 - 1964, p.31 TILLINGHAST - "The Carter Commission Report and Int e r n a t i o n a l Investment Transactions; Integration and ambiguous Intentions" 1969 (22) National Tax Journal, p.79 WARD - "International Operations : Trading Companies" (1965 Corporate Management Conference) - Canadian Tax Papers n.41 - 1965,p.29 151 WRIGHT - "F a i r Market Value and Security Valuation under the B i l l " 1971 Canadian Tax Journal,p.500 The Canada Tax Service L e t t e r (H.H.S.) - Management or Administration Fee or Charge" n.84-January 1964 (H.H.S.) - "Non-Residence : Can You Go Without Leaving?" n.l40-July 1969 (H.H.S.) - 'The White Paper and International Proposals" n.l44-December 1969 (H.H.S.) - "Technical Service Fees are R o y a l t i e s " n . l 6 2 - A p r i l 1971 (G.T.T.) - "Freeing 1971 Corporate Surplus" n. 166-August 1971 (H.H.S.) - "More Problems f o r Non-Residents under New System" n. 167-August 1971 (H.H.S.) - "A New Breed of Tax Haven" n.l76-December 1971 (A.P.F.C.) - "The future Use of NROs" n. 177-January 1972 152 TABLE OF CASES Page Abed Heskel v. M.N.R., 1971 DTC 131 33, 36, 39 Avent v. M.N.R., 1950 DTC 437 11 Beament v. M.N.R., 1952 DTC 1183 11, 12 Bedford Overseas Freighters Ltd. v. M.N.R., 1970 DTC 6072 20 Belfour v. Mace, 13 (1928) TC 539 31, 34 B.C. Brick & T i l e Co. Ltd. v. The King, 1936/37 ExCR 71 35 B.C. E l e c t r i c Railway Co. Ltd. v. The King 2 (1945) DTC 692, 2 (1946) DTC 824, 2 (1946) DTC 839 21 S.I. Burland Properties Ltd. v. M.N.R., 1967 DTC 5289, 1968 DTC 5220 77 Cayuga Realty Ltd. v. M.N.R., 1955 DTC 386 99 Cooper v. Cadwalader, 5 (1904) TC 101 11 Crossley Carpets (Canada) L t d . v. M.N.R., 1969 DTC 5051 20 De Beers Consolidated Mines Ltd. v. Howe, 1906 AC 455 18 The Deltona Co. v. M.N.R., 1971 DTC 5186 23 Desoutter Brothers l t d . v. I.R.C, (1946) 1 A l l ER 58 144 Egyptian Delta Land & Investment Co. Ltd. v. Todd, 1929 AC 1 19 Englis h E l e c t r i c v. Musker, 1964 TR 129 84 Erichsen v. Last, 1880/82 QB 414 30 Evans Medical Supplies Ltd. v. Moriarty, 37 (1957) TC 54 85 Firestone T i r e & Rubber Co. of Canada Ltd. v. C.I.T. 1942 SCR 476 31, 35 Grainger & Son v. Gough, 1896 AC 325 31 Gray v. M.N.R., 1969 DTC 754 18 J a v e l i n Foundries & Machine Work Ltd. v. M.N.R., 1967 DTC 392 143 153 K o i t a k i Para Rubber Estates Ltd. v. Federal Commissioner for Taxation, (1941) 64 CLR 241 241 Korican v. M.N.R., 1971 DTC 39 12, 15 Lea-Don Canada L t d . v. M.N.R., 1969 DTC 5142, 1970 DTC 6271 80 Levene v. I.R.C., 1928 AC 217 10 Lysaght v. C.I.R., 1928 AC 234 10, 12 Manitou-Baune Mines Ltd. v. M.N.R., 1966 DTC 5001 70 Meldrum v. M.N.R., 4 (1950) DTC 232 11 National Trust Co. L t d . , trustee of Sam Gorman v. M.N.R. 1954 DTC 33 93, 143 Neuberger Ann v. M.N.R., 1969 DTC 127 33, 36, 39 Palmolive Manufacturing Ltd. v. The King,(1933) 2 DLR 85 35 P.R. Oearson, trustee i n Bankruptcy for William P i t t Hotel Ltd. v. M.N.R., 1964 DTC 224 143 Peninsular Investments Ltd. v. M.N.R., 1961 DTC 702, 1963 DTC 1149 101 P.H. Perry Estate Inc. v. M.N.R., 1952 DTC 202 37, 39 Petersen v. M.N.R., 1969 DTC 503 15 Quality Chekd Dairy Products Ass'n v. M.N.R., 1967 DTC 5303 87 Recker Holly v. M.N.R., 1971 DTC 232 12 Rolls v. M i l l e r , (1884) 53 L J Ch 99 29 Rolls-Royce Ltd. v. J e f f r e y , 1962 TR 9 83, 84, 85 Ross & Co. L t d . v. M.N.R., 1967 DTC 421 36, 42 Rubinstein v. M.N.R., 1962 DTC 100 39, 42 Russel v. M.N.R., 1949 DTC 536 10 Samson v. M.N.R., 2 (1943) DTC 610 29 Schujahn v. M.N.R., 1962 DTC 1225 13, 18 Smidth & Co. v. Greenwood, (1922) 1 AC 417 31 Smith v. Anderson, (1880) 15 ChD 247 29 Standard Fashion Co. v. McLeod, (1914) 6 WWR 939 34 Swedish Central Railway Co. Ltd. v. Thompson, 1925 AC 495 19 Swiss Bank Co. and Swiss C r e d i t Bank v. M.N.R., 1971 DTC 5235 69 154 Tara Exploration & Development Co. Ltd. v. M.N.R. 1970 DTC 6370 21, 33 Technical Tape Corp. v. M.N.R., 1964 DTC 428 84, 85, 89 Thea Co. v. M.N.R., 1967 DTC 175 33, 36 Thomson v. M.N.R., 2 (1946) DTC 812 10, 11, 13, 14 Tootal Broadhurst Lee & Co. Ltd. v. I.R.C, (1949) 1 A l l ER 261 144 Turner (Leicester) Ltd. v. Rickman, 4 (1898) TC 25 34 Union Corporation L t d . v. I.R.C, (1952) 1 A l l ER 646 19 Union O i l Co. of C a l i f o r n i a v. M.N.R., 1966 DTC 130 59 Unit Construction Co. L t d . v. Bullock, 1960 AC 357 20 United A i r c r a f t Corp. v. Commissioners,(1943) 68 CLR 525 144 United Geophysical Co. of Canada v. M.N.R., 1961 DTC 1099 31, 37, 92 Walsh Ltd. v. M.N.R., 1955 DTC 593 143 Warsh;.&_Co.Ltd. v. M.N.R., 1962 DTC 247 82 Watson v. Sandie H u l l , (1898) 1 QB 326 34 Western E l e c t r i c Co. Inc. v. M.N.R., 1969 DTC 5204 86 C A . Graf von Westphalen v. M.N.R., 1964 DTC 194 39 Wilcock v. Pinto & Co., 1925 KB 30 34 Withy, Furness & Co. L t d . v. M.N.R., 1966 DTC 5358 1968 DTC 5033 44, 59 Yamaska Steamship Co. Ltd. v. M.N.R., 1961 DTC 716 20 Zehnden & Company v. M.N.R., 1970 DTC 6064 139 N. 416 v. M.N.R., 1957 DTC 230 12, 18 N. 479 v. M.N.R., 1958 DTC 9 100 N. 664 v. M.N.R., 1962 DTC 1338 88

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