Canada’s Notice of Ways and Means Motion Introduces changes to FAPI and Withholding of Tax Rules

Par Robert Robillard - 19 avril 2016

This blogpost originally appeared on rbrt.ca.

The Notice of Ways and Means Motion to implement certain provisions of the budget tabled in Parliament on March 22, 2016 and other measures and Explanatory Notes introduces changes to withholding of tax by a nonresident employer and some subtle changes to FAPI calculation.

Regarding FAPI calculation, the Notice explains (see pp. 19-20):

« Determination of certain components of foreign accrual property income
ITA
95(2)(a.2) to (a.23)

Paragraph 95(2)(a.2) of the Act includes in the income from a business other than an active business and thus the foreign accrual property income (“FAPI”) of a foreign affiliate of a taxpayer resident in Canada, the income of the affiliate from the insurance of risks (including income from the reinsurance of risk) where the risks insured were in respect of

 a person resident in Canada
 property situated in Canada, or
 a business carried on in Canada.

The rule does not apply, however, where more than 90% of the gross premium income of the affiliate from the insurance (net of reinsurance ceded) of risks was derived from the insurance of other risks of persons with whom the affiliate deals at arm’s length. Where the rule applies to the foreign affiliate of the taxpayer, the insurance of those risks is deemed to be a separate business other than an active business of the affiliate.

Paragraph 95(2)(a.2) is amended in two ways. First, it is modernized and restructured, by replacing its former subparagraphs (a.2)(i) to (iii) with references to the new defined term “specified Canadian risks”, which are defined in new paragraph 95(2)(a.23) as the same risks that were previously described in those subparagraphs. It is further restructured by moving the existing rule into new subparagraphs (a.2)(i) and (ii), to accommodate the addition of the new rules in new subparagraphs (a.2)(iii) and (iv). The changes described above are merely structural and not substantive changes.

Second, paragraph (a.2) is amended by adding new rules in subparagraphs (a.2)(iii) and (iv). Subparagraph (a.2)(iii) provides that, to the extent income in respect of the ceding of Canadian risks is not already included in a foreign affiliate’s income from a business other than an active business because of subparagraph (a.2)(i) or (ii), it is to be so included. For these purposes, an affiliate’s income in respect of the ceding of Canadian risks includes (but is not limited to):

 income of the affiliate from services in respect of the ceding of specified Canadian risks, and
 the amount, if any, by which the fair market value of the consideration provided in respect of the ceding of the specified Canadian risks exceeds the affiliate’s cost in respect of those specified Canadian risks.

Subparagraph (a.2)(iv) is analogous to subparagraph (a.2)(ii) and, where subparagraph (a.2)(iii) applies in respect of the ceding of specified Canadian risks, deems

 the ceding of those risks to be a separate business, other than an active business, carried on by the affiliate, and
 any income of the affiliate that pertains to or is incident to that business to be from a business other than an active business.

Paragraph 95(2)(a.21) is amended by adding references to the new defined term “specified Canadian risks”. No substantive changes are made to this paragraph.

New paragraph 95(2)(a.23) defines the new term “specified Canadian risks”, for purposes of paragraphs (a.2) and (a.21). These risks are the same ones that were previously described in subparagraphs (a.2)(i) to (iii), and the new definition replaces the description previously in those subparagraphs.

Specifically, specified Canadian risks are defined as risks in respect of a person resident in Canada, a property situated in Canada or a business carried on in Canada.

These amendments apply to taxation years of a taxpayer that begin after April 20, 2015.

Example: Paragraph 95(2)(a.2)(iii) and (iv)
Assumptions

 FA1 is a non-resident corporation, all of the shares of which are owned by a corporation resident in Canada (“Canco”).
 FA1 reinsures risks of an arm’s length Canadian insurance company, which constitute “specified Canadian risks” (as defined in paragraph (a.23)), and pays a cash “ceding commission” to the Canadian insurance company.
 Subsequently, FA1 retrocedes these risks to an arm’s length, non-resident reinsurer. As part of the same arrangement, the non-resident reinsurer also retrocedes foreign risks to FA1.
 Paragraph (a.21) does not apply to deem the foreign risks to be specified Canadian risks because, based on certain other facts concerning the arrangement, the condition in subparagraph (a.21)(ii) is not satisfied.

Analysis

To the extent income in respect of the ceding of the Canadian risks by FA1 to the non-resident reinsurer is not already included in FA1’s income from a business other than an active business because of subparagraph (a.2)(i) or (ii), subparagraphs (a.2)(iii) and (iv) will apply in this case. In this regard, subparagraph (a.2)(iii) provides that, for these purposes, a foreign affiliate’s income from the ceding of Canadian risks includes an amount equal to the difference between the fair market value of the consideration provided in respect of the ceding of the specified Canadian risks and the affiliate’s cost in respect of those specified Canadian risks. Since, as part of the same arrangement under which the non-resident reinsurer reinsures the specified Canadian risks, FA1 also reinsures the foreign risks of the non-resident reinsurer, the portfolio of foreign risks constitute consideration provided by the non-resident reinsurer in respect of the ceding of the specified Canadian risks by FA1. Accordingly, FA1’s income from the ceding of the specified Canadian risks is equal to the difference between the fair market value of the foreign risks and FA1’s cost in respect of those specified Canadian risks (which costs may include the ceding commission paid by FA1 to the Canadian insurance company). »

With respect to withholding of tax by a nonresident employer, the Notice indicates (p. 53):

« Withholding
ITA
153(1)(a)

Section 153 of the Act requires the withholding of tax from certain payments described in paragraphs 153(1)(a) to (t). The person making such a payment is required to remit the amount withheld to the Receiver General on behalf of the payee. Paragraph (a) requires withholdings with respect to salary, wages and other remuneration paid to an employee, including a nonresident employee working in Canada for a non-resident employer, other than amounts described in subsection 115(2.3) (relating to the 2010 Vancouver Olympics) or 212(5.1) (relating to certain acting services).

Paragraph (a) is amended to exclude from the withholding obligations, in addition to amounts described in 212(5.1), amounts paid at any time by a qualifying non-resident employer to a qualifying non-resident employee if, at the time of the payment, the employee is a “qualifying non-resident employee” and the employer is a “qualifying non-resident employer”, both as defined in subsection 153(6). The reference to subsection 115(2.3) is no longer necessary and so, it is not included in the revised paragraph (a).

This amended paragraph applies in respect of payments made after 2015. »

The complete legislative provisions are available here : http://www.fin.gc.ca/drleg-apl/2016/bia-leb-0416-l-eng.asp

The library on Transfer Pricing in Canada is available here.

Robert Robillard, Ph.D., CPA, CGA, Adm.A., MBA, M.Sc. Econ., M.A.P.
Senior Partner, RBRT Inc.
514-742-8086; robertrobillard « at » rbrt.ca
www.rbrt.ca

The convergence of RBRT’s tax, accounting and economics expertise makes a difference. The information in this blog post is general information only. Data and information come from sources believed to be reliable but complete accuracy cannot be guaranteed. RBRT Inc. or the author are not responsible or liable for any error, omission or inaccuracy in such information. The opinions expressed in this blogpost are those of the author. Readers should seek advice and counsel from RBRT Inc. as required.