CANADA Trends and Developments Contributed by: Grant McGlaughlin, Sean Stevens and Claire Gowdy, Fasken
shares of a foreign entity (ie, the parent company of the business). Since this latter exchange will be a tax - able event for the Canadian resident shareholders, the exercise of exchange rights does not usually occur until the shareholders are ready to dispose of their investment so that the sale proceeds can be used to cover their Canadian tax liability. Foreign intermediaries and treaty shopping Canada has been an active participant in the Base Ero - sion and Profit Shifting (BEPS) project of the Organi - sation for Economic Co-operation and Development (OECD). In connection with the BEPS project, Canada has ratified the Multilateral Instrument (MLI) effective 1 December 2019, and adopted the minimum standards proposed by the OECD. In the past, foreign investors have commonly invested in Canada through corporate holding companies in Luxembourg or the Netherlands, for example. How - ever, this practice has been impacted by the provi - sions of the MLI, which has introduced specific treaty shopping restrictions to most of Canada’s tax trea - ties – but, notably, not the Canada–United States Tax Convention (the “Canada–US Treaty”), which already includes limitation-on-benefits provisions. Care should be taken when investing in Canada through a foreign holding company to ensure desired treaty benefits are available. Dividend withholding tax Dividends paid by a Canadian company to a share - holder that is a non-resident of Canada are generally subject to a withholding tax of 25%. Dividend withholding taxes may be reduced where the recipient shareholder is a resident of a jurisdic - tion with which Canada has a tax treaty. For exam - ple, dividends paid to a US resident that qualifies for treaty benefits are subject to a withholding tax rate of 15%. The Canada–US Treaty provides an even lower withholding rate where the US resident shareholder receiving dividends is a corporation that owns 10% or more of the voting stock of the Canadian corporation. Interest withholding tax Generally speaking, interest paid by a Canadian resi - dent corporation to an arm’s length non-resident lend -
er should not be subject to Canadian withholding tax. Interest paid to a non-arm’s length non-resident lend - er, however, is subject to a 25% withholding tax. That being said, Canada’s tax treaties typically reduce the withholding tax imposed on non-arm’s length interest payments to 10%. Notably, however, the Canada–US Treaty generally provides that US resident lenders are exempt from Canadian interest withholding tax even where such lenders are non-arm’s length with the Canada’s thin capitalisation rules may limit interest deductibility for Canadian companies with respect to certain loans from specified non-resident sharehold - ers. Generally, interest on such loans is not deductible for Canadian tax purposes where the Canadian cor - poration’s debt-to-equity ratio exceeds 1.5 to 1. For these purposes, the “equity” is the aggregate of the Canadian corporation’s retained earnings, contributed surplus and paid-up capital, calculated at different times, that are attributable to specified non-resident shareholders. A “specified non-resident shareholder” is a non-resident that holds shares representing 25% or more of the outstanding shares of the Canadian company, by votes or value, or does not deal at arm’s Canadian borrower. Thin capitalisation Generally speaking, capital gains realised by a for - eign investor upon a disposition of shares in the capi - tal stock of a Canadian company are not subject to Canadian tax unless the shares are “taxable Canadian property”. Canadian private company shares will be considered taxable Canadian property if, at any time during the preceding 60 months, the shares derived their value principally from real property situated in Canada, timber resource properties or Canadian resource properties. Canadian tax treaties may offer relief in respect of Canadian capital gains taxes arising on the disposi - tion of taxable Canadian property in limited circum - stances. However, regarding Canadian tax treaties subject to the MLI, a 365-day look-back rule may find application in allowing Canada to tax capital gains realised by non-resident persons on shares or other length with any such shareholder. Exit from Canadian investment
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