CANADA Law and Practice Contributed by: Marc-André Godard, Pierre Allard, Isabelle Gagnon and Mehrez Houacine, BCF Business Law LLP
Notable exceptions are where the loan is repaid within one year after the end of the lender’s taxation year and the repayment is not part of a series of loans and repayments, or where the loan is considered a “per - tinent loan or indebtedness” (PLOI) under the PLOI regime. In such a scenario, the Canadian corporation must include a deemed interest income in its taxable income. Canada also has “excessive interest and financing expense limitation rules”, the purpose of which is to restrict interest and financing deductions to a pro - portion of the profits of certain taxpayers. In general terms, interest expenses are required not to exceed 30% of taxable income calculated before interest income, interest expense, income taxes, and depre - ciation expense. Any portion of an interest expense in excess of such percentage is generally not deduct - ible in computing income. A deduction so denied may be carried forward indefinitely, provided it is within the above percentage in the year the deduction is claimed. Also, an election may be made to transfer unused cumulative excess deductions within a group of eligible corporations in Canada. 6. Taxation of Foreign Income of Local Corporations 6.1 Foreign Income Exemptions A Canadian-resident corporation is subject to Cana - dian corporate income tax on worldwide income. For - eign income is taxed in Canada at the same federal and provincial corporate tax rates as local income. However, if a corporation has income sourced from another country and is taxed in that other country, it could be entitled to apply for foreign tax credits against its tax payable in Canada, to prevent double taxation on the same income. Separate foreign tax credit calculations are prescribed for business and non-business income on a country-by-country basis. 6.2 Non-Deductible Local Expenses Generally, local expenses are non-deductible unless they are made or incurred to earn income from a busi - ness or property. Therefore, local expenses made or incurred for the purpose of earning foreign business
or property income would normally be deductible to reduce the taxpayer’s net income. 6.3 Dividends From Foreign Subsidiaries Canadian taxation of a dividend received from a foreign corporation will depend on the foreign cor - poration’s qualification. As a general rule, dividends must be included in computing the recipient’s tax - able income. If the foreign corporation is not a for - eign affiliate (FA) of the dividend recipient, no relief will be available for the foreign corporation’s underly - ing taxes. An FA is a foreign corporation of which a Canadian corporation owns an equity percentage of at least 1% of any class of its outstanding shares, and the same Canadian corporation owns – alone or together with related persons (individuals or corpora - tions) – an equity percentage of at least 10% of any class of its outstanding shares, in which the notion of “equity percentage” refers to shares held directly or indirectly, through another entity. When an FA pays a dividend to a Canadian corpora - tion, the FA’s surplus account must be determined. The four different surplus accounts accumulate dif - ferently and their treatment differs. Exempt Surplus Treatment An exempt surplus is generally ABI earned by an FA that is resident in, and carries on an active business in, a country with which Canada has signed a tax treaty. A dividend from this surplus account is fully deduct - ible to the Canadian corporation receiving it. If the FA is resident in a non-treaty country, a dividend paid to the Canadian may also qualify as exempt surplus if the foreign country has entered into a tax information exchange agreement with Canada. Hybrid Surplus Treatment Hybrid surplus will generally include 100% of any gains from the sale of shares of an FA and/or partner - ship interest by another FA, provided certain condi - tions are met. Dividends paid out of hybrid surplus are included in the Canadian corporation’s income, though a 50% deduction and relief in respect of underlying foreign taxes may be available. The 2024 federal budget proposed to increase this inclusion rate after 24 June 2024 to 66% in the same proposals outlined in 2.7 Capital Gains .
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