2021 Federal Budget Highlights for International Tax

The Federal Government tabled its first budget in more than two years on April 19, 2021, proposing a number of measures to support businesses and individuals through the pandemic and into recovery.

There were a significant number of tax measures announced in the 2021 Budget, including some international tax items worth noting. The international tax measures are proposals that offer some specifics on items previously announced and are expected to raise federal revenues. A detailed analysis of these measures will be prepared once draft legislation is made available, likely in the upcoming summer months.

National tax on non-resident-owned residential properties

Budget 2021 proposes a federal one-percent tax on the value of certain Canadian real property owned by non-residents, beginning in 2022. The tax will apply to non-resident, non-Canadian owned residential real estate considered vacant or underused. 

In the coming months, the Government will release a backgrounder and provide for consultation to gain comments on the scope of the tax, including whether special rules should be established for certain tourism-based communities. It is likely an annual certification of declaration will be required of non-residents potentially subject to the tax.

Corporate tax measures and BEPS international reporting framework

For those who have been following the Action Plan on Base Erosion and Profit Shifting (BEPS)[1] since the Organisation for Economic Co-operation and Development (OECD) first published it in 2013 and its potential impact on the Canadian tax system, the international tax aspects of Budget 2021 contain no real surprises. The proposed interest deductibility limits are consistent with the OECD’s 2015 recommendations in BEPS Action 4 and the hybrid mismatch proposals are aligned with the OECD’s BEPS Action 2 recommendations.

Budget 2021 does not contain any draft legislation for either of these proposals; the Government has announced that draft legislation may be expected in the summer of 2021.

Interest deductibility limits

Budget 2021 proposes to add further limits on interest deductions for Canadian corporations, partnerships, trusts and branches of non-resident taxpayers. Under the proposal, deductible interest will be limited to a fixed ratio of tax EBITDA. Details of the computation of tax EBITDA were not included in Budget 2021, but it can generally be described as taxable income (excluding deductible dividend income and interest income) computed before interest expense, taxes, depreciation and amortization. 

The fixed ratio interest deduction limit is 40 percent for tax years beginning on or after January 1, 2023, then 30 percent for tax years beginning on or after January 1, 2024. There does not appear to be grandfathering of existing debt. The budget contemplates a “group ratio” rule to permit a taxpayer to deduct interest in excess of the fixed ratio where the ratio of net third-party interest to book EBITDA of the consolidated group is higher than the fixed ratio.

Denied interest expense will be subject to a 20-year carry-forward period as well as a three-year carry-back period to tax years where deductible interest expense was less than the fixed ratio. Certain Canadian-controlled private corporations (CCPCs) that have annual interest expense less than $250,000, or CCPCs together with their associated group, that have less than $15 million of taxable capital, will be exempt from these rules.

Taxpayers will need to assess their capital structures for tax efficiency in light of possible interest expenses limits.

Hybrid mismatch arrangements

Hybrid mismatch arrangements are transactions or instruments characterized differently under the tax laws of different countries. Hybrid arrangements typically exist because the tax laws of any given country are unlikely to be identical to another country, and this provides a means for multinational organizations to erode the tax base in a foreign country. An example is a financial instrument that creates a tax-deductible expense for the payer in one country yet another country views that payment as a non-taxable income item for the recipient.

Budget 2021 appears to be following the Action 2 report of the BEPS Action Plan which recommends countries adopt rules to eliminate the tax benefits of hybrid mismatch arrangements. The Government has categorized hybrid mismatch transactions into four categories:

• Cross-border payment that create deductions in one country but are not included as income in the other country,
• Deductions claimed in more than one country for the same outlay,
• Mismatches that involve three countries where an initial income inclusion in a second country is offset by a hybrid mismatch arrangement with a third country, and
• Mismatches involving branches where there are diverging views between the residence country and the branch country as to where the branch is located for purposes of the allocation of revenue and expenses between the two countries.

The Government plans to address transactions that fall into the first category in draft legislation this summer (proposed to be in force by July 2022). Hybrid transactions in the other categories will be addressed in a separate package of draft legislation.

Transfer Pricing proposals

Budget 2021 proposes to release a consultation document on modifications to the Canadian transfer pricing rules. The move is intended to address what the Government views as deficiencies in Canada’s current transfer pricing rules that result in “the inappropriate shifting of corporate income out of Canada, artificially reducing corporations’ taxes owed in Canada” and pose “a risk to the integrity of Canada’s corporate income tax system.” This view is seen largely as a response to the Supreme Court of Canada’s decision not to hear the Government’s appeal of the Federal Court of Appeal’s unanimous decision against the Government in The Queen v Cameco Corporation.

As some background to the case, Cameco incorporated a Swiss subsidiary to purchase Russian uranium for resale to third parties, and to purchase uranium for resale from Cameco. The Crown was unsuccessful in arguing Cameco long-term uranium pricing contracts and arrangements between it and its foreign subsidiaries did not meet the arm’s length standard and that transfer pricing adjustments were warranted to attribute more profit to Canada. Both the Tax Court and the Federal Court of Appeal findings in favour of the taxpayer found that at the time the uranium contracts and arrangements were entered into, the price of uranium was low and the pricing used within the contracts were in the range of arm’s length pricing.

Budget 2021 also proposes to advance the 2019 draft amendments to the transfer pricing rules so as to apply the transfer pricing rules in priority to any other provisions of the Act.