2016-0632711I7 ON Tax and Brazilian Tax Sparing

Principal Issues: 1. Are Ontario taxpayers entitled to a provincial foreign tax credit in respect of spared taxes under Article 22 of the Canada-Brazil treaty? 2. In addition to the reasons given in 2014-0525961I7, can the FTC be denied on the basis that Regulation 183 of ON Revised regulations denies the credit because the treaty is not one of the listed treaties?

Position: 1. No. 2. No.

Reasons: 1. As stated in 2014-0525961I7, Ontario is not a party to the treaty and has not incorporated the treaty into the provincial foreign tax credit system. 2. Section 802 of Regulation 183 is not applicable to section 34 of the ON TA. Further, section 802 is not a restrictive provision, but expands what is included in tax paid. Therefore, the absence of the treaty from section 802 does not deny the amounts; it only fails to make them eligible.

Author: Young, Terry
Section: ON TA 1(8), 34; ON CTA 40; ITA 126(7); Canada-Brazil Tax Treaty Art. 22

                                                                                                                   April 13, 2016

XXXXXXXXXX TSO                                                                                  HEADQUARTERS
                                                                                                                  Income Tax Rulings
                                                                                                                  Directorate
XXXXXXXXXX                                                                                          Terry Young
                                                                                                                  (613) 670-9031

                                                                                                                  2016-063271

Spared taxes under the Canada-Brazil Income Tax Convention and the Ontario Taxation Act, 2007

We are writing in response to your email of January 15, 2016, which was forwarded to us on February 18, concerning whether amounts of tax deemed to have been paid (“spared taxes”) by some of Canada’s income tax conventions, qualify for a provincial foreign tax credit. In particular, your letter concerned whether spared taxes under paragraph 3 of Article 22 of the Canada-Brazil Income Tax Convention (“Brazilian spared taxes” and the “Brazil Treaty”, respectively) are eligible for the foreign tax credit (the “ON FTC”) under subsection 34(1) of Ontario’s Taxation Act, 2007 (the “ON TA”). For taxation years beginning before 2009, the ON FTC was calculated pursuant to section 40 of the Ontario Corporations Tax Act (the “ON CTA”). Your request is further to our June 16, 2014, memo (our reference 2014-0525961I7) on the same issue. In particular, you have provided us with a secondary basis supporting our conclusion that the Brazilian spared taxes are not eligible for the ON FTC. You have asked us for our comments.

Background

Section 34 of the ON TA provides a tax credit, which may be deducted from Ontario income tax payable, for tax paid to a jurisdiction outside Canada on investment income earned in that jurisdiction. Section 34 states, in part:

“(1) Foreign tax credit — A corporation that is resident in Canada throughout a taxation year and has foreign investment income for the year may, in computing its tax payable under this Division for the year, deduct a foreign tax credit equal to the lesser of,

(a) the amount calculated under subsection (2) for the year; and

(b) the amount calculated under subsection (3) for the year.

(2) Same — For the purposes of clause (1)(a), the amount is determined by multiplying the corporation's Ontario domestic factor for the taxation year by the amount, if any, by which “A” exceeds “B” where,“A” is the portion of the non-business-income tax paid for the year by the corporation to the government of a country other than Canada that relates to foreign investment income of the corporation for the year that is not from a share of the capital stock of a foreign affiliate of the corporation, and

“B” is the amount deductible by the corporation in respect of the foreign investment income for the year under subsection 126(1) of the Federal Act.”

Our understanding of the situation at hand is that in computing its federal and Ontario income tax liability the taxpayer reported non-business interest income from Brazilian sources. The taxpayer claimed an ON FTC under subsection 34(1) of the ON TA in respect of the Brazilian-sourced income.

The ON FTC claimed by the taxpayer represents the Ontario portion (based on the provincial income allocation formula) of the excess of the Brazilian spared taxes over the non-business foreign tax credit claimed by the taxpayer in respect of the Brazilian spared taxes for federal income tax purposes under subsection 126(1) of the Income Tax Act ( the “ITA”).

In brief, in our earlier memo, we agreed with your reasoned position and stated that it is our view that the Brazilian spared taxes are not eligible for the ON FTC under subsection 34(1) of the ON TA because the Province of Ontario is not a party to the Brazil Treaty and the province has not incorporated the Brazil Treaty into the ON FTC provisions of the ON TA.

Secondary Basis

As a secondary basis in support of that conclusion, you have proposed the following:

*     Section 802 of Ontario Regulation 183 of the Corporation Tax Act of Ontario (“Regulation 183”) lists prescribed conventions for which the Province of Ontario grants foreign tax credits for spared taxes.

*     The Brazil Treaty is not one of those listed in section 802 of Regulation 183. Therefore, Ontario did not grant foreign tax credits on Brazilian spared taxes for taxation years that ended prior to 2009.

*     For taxation years ending after December 31, 2008, the Province of Ontario harmonized its income tax with the Federal government.  The ON TA is the primary Ontario tax statute. It combines/replaces the personal tax measures found in the Ontario Income Tax Act and the corporate tax measures found in the CTA.

Taxpayer’s Position

You have advised us that it is the taxpayer’s position that Regulation 183 did not continue into the ON TA and, therefore, could not be relied on to disallow the ON FTC.  Further and, in particular, even if Regulation 183 continues to apply for purposes of the ON TA, section 34 of the ON TA does not refer to a prescribed convention/amount that connects section 34 to Regulation 183 meaning that section 802 of Regulation 183 does not apply to section 34 of the ON TA.

Audit’s Position

It is Audit’s position that section 802 of Regulation 183 continues into the ON TA because of subsection 26(6) of the ON TA, which states:

“A reference in any provision in this Part to something prescribed, determined or defined by the regulations shall be read as a reference to the thing as prescribed, determined or defined by the regulations made for the purposes of the corresponding provision of the Corporations Tax Act unless a regulation has been made under this Act to prescribe, determined or define the thing.”

In addition and due to the fact that sections in the ON CTA referred to in the Regulations may not be identical to or have the same numbers as their corresponding sections in the ON TA, subsection 26(7) of the ON TA states: 

“A regulation made under the Corporations Tax Act that applies for the purposes of this Part shall be read with such modifications as may be required.”

The reasonable conclusion from the above is that Regulation 183 continues into the ON TA and that a reference by section 802 of the regulation to section 40 of the ON CTA is a reference to section 34 of the ON TA.

The argument by the taxpayer that section 34 of the ON TA did not mention the word prescribe, which links this section to section 802 of Regulation 183, will not succeed.  Section 40 of the ON CTA also did not mention the word “prescribe”, and yet taxpayers were prevented from claiming Ontario foreign tax credit with respect to spared taxes that were not prescribed conventions.  This is because section 802 started with the phrase “In the application of section 40 of the Act and subsection 20(12) of the Income Tax Act (Canada)”.  Therefore, this regulation modifies the amount that is otherwise determined in section 34 of the ON TA.

The use of the word “determined” found in subsection 34(2) is sufficient to fit within the words, “(a) reference in any provision in this Part to something prescribed, determined or defined by the regulations…” in subsection 26(6) of the ON TA such that the application of subsection 34 can be modified by regulation.

Section 802 of Regulation 183 determines the foreign tax creditable by modifying section 34 to include spared taxes as taxes paid only with respect to the prescribed conventions contained therein.  In other words, section 802 serves as another layer that overrides provisions in the ON TA where it piggy-backs with the rules of the ITA, as it applies to subsection 126(1) of the ITA.  Another example would be that of the normal reassessment period where the ON TA piggy-backs onto the rules found in subsections 152(3.1) of the ITA and its related provisions by virtue of subsection 112(2) of the ON TA.  However, the ON TA has another provision that overrides this rule by virtue of 114(1), wherein the Ontario Minister has an additional year to reassess.

Our Comments

Since the question of whether the Brazilian spared taxes are otherwise eligible for the ON FTC was addressed in our 2014 memo, our comments will address only the proposed secondary basis for denying the ON FTC, i.e., whether section 802 of Regulation 183 will deny the ON FTC.

As a general legal principle, in order for a regulation to modify provisions of legislation, the legislation must explicitly allow for it. As noted above, although section 40 of the ON CTA did not contain anything that provided for the application of Regulation 183, we note that subsection 1(8) of the ON CTA did. Subsection 1(8) stated:

Where,

(a) a corporation is subject to tax under this Act and under the Income Tax Act (Canada); and

(b) the corporation's liability for tax under the Income Tax Act (Canada) is subject to and modified by the application of the provisions of a Tax Treaty, Agreement or Convention between Canada and another country,

the provisions of this Act may be modified and applied in the manner prescribed by the regulations for the purpose of giving effect to a provision of such a Treaty, Agreement or Convention for the purposes of this Act, and regulations related to this subsection may have retroactive application if they so state. (our emphasis)

Thus, subsection 1(8) of the ON CTA provided authority for section 40 to be modified by regulation.

As noted above, subsections 26(6) and (7) of the ON TA provide that regulations under the ON CTA will apply to Part III of the ON TA (i.e., corporate tax) where the provision in Part III includes a reference to “something prescribed, determined or defined by the regulations”. This means that, in general, regulations under the ON CTA can continue to apply under the ON TA. However, section 34 of the ON TA does not include a reference as described in subsection 26(6) nor does the ON TA contain a provision similar to subsection 1(8) of the ON CTA. Without such a reference or provision, section 802 of Regulation 183 cannot apply to section 34 of the ON TA to restrict the eligibility of the tax spared amounts for the ON FTC.

Notwithstanding this conclusion, we will address the question of whether section 802 would restrict the eligibility of the spared taxes if it did apply to section 34 of the ON TA.

Section 802 of Regulation 183 states:

“PART VIII PRESCRIBED TAX CONVENTIONS

802. In the application of section 40 of the Act …, the income or profits tax paid by a corporation to a jurisdiction outside Canada for a taxation year, … shall include an amount of tax that would have been payable by the corporation to that jurisdiction or government but for an exemption from, or reduction of, tax granted for that taxation year if the amount is deemed under one of the following income tax agreements or conventions to have been tax payable or paid for the taxation year by the corporation to that jurisdiction or government:

[List of applicable tax agreements or conventions of which the Brazil Treaty is not one.]” (our emphasis)

In order to be eligible for the ON FTC, a foreign tax had to be paid. Spared taxes are not actually paid. Section 802 deems spared taxes under certain tax agreements or conventions (“treaty” or “treaties”) to be tax paid for purposes of section 40 of the ON CTA if the treaty was listed in section 802. If a treaty was not listed, no amount in respect of the spared taxes was deemed to be tax paid for purposes of section 40. Therefore, in our view, section 802 did not make an amount that was otherwise eligible for the ON FTC under the ON CTA ineligible. Instead, if a particular treaty was not listed (for example, the Brazil Treaty), section 802 simply had no effect. Therefore, even if section 802 applied to section 34 of the ON TA, the absence of the Brazil Treaty from the listed treaties would not prevent the Brazilian spared taxes from being eligible for the ON FTC (if they were otherwise eligible). Instead, it would only mean that section 802 did not apply to deem the Brazil spared taxes to be “tax paid” for purposes of section 34 of the ON TA.

The result is that the question of whether section 802 of Regulation 183 applies to section 34 of the ON TA is irrelevant because, even if section 802 did apply, it would not affect the eligibility of the Brazilian spared taxes for the ON FTC.

However, in our view, the wording of section 802 does indicate that our overall conclusion that Brazilian spared taxes are not eligible for the ON FTC is consistent with tax policy. The expansive wording (i.e., shall include) used in section 802 indicates that, in the view of the Ontario Ministry of Finance, the spared taxes did not otherwise qualify for the ON FTC. Further, Ontario Information Bulletin 2741, Ontario Budget 1988, confirms the intention at that time that spared taxes would only qualify if the treaty was prescribed. Specifically, the Information Bulletin stated that one of the required conditions for spared taxes to be eligible for the ON FTC was that:

“3. The treaty has been reviewed by this Branch and has been accepted for this purpose.  Eligible treaties will be prescribed by the Corporations Tax Regulations.”

Conclusion:

Section 802 of Regulation 183 does not apply to section 34 of the ON TA because there is no provision in the ON TA that makes section 802 applicable. Further, because section 802 is a provision that expands what is eligible for the ON FTC and does not make amounts that are otherwise eligible for the on FTC ineligible, even if section 802 did apply, it would not make the Brazilian spared taxes ineligible for the ON FTC if they were otherwise eligible.

In any case, for the reasons given in our June 16, 2014, memo, we continue to be of the view that the Brazilian spared taxes are not eligible for the ON FTC.

For your information, unless exempted, a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Canada Revenue Agency’s electronic library. A severed copy will also be distributed to the commercial tax publishers, following a 90-day waiting period (unless advised otherwise to extend this waiting period), for inclusion in their databases. The severing process will remove all material that is not subject to disclosure, including information that could disclose the identity of the taxpayer. Should the taxpayer request a copy of this memorandum, they may request a severed copy using the Privacy Act criteria, which does not remove taxpayer identity. Requests for this latter version should be e-mailed to: ITRACCESSG@cra-arc.gc.ca. In such cases, a copy will be sent to you for delivery to the taxpayer.

We trust these comments will be of assistance.

Terry Young, CPA, CA
Section Manager
for Director
International Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch

c.c.  Leslie Bafia, ILBIB
        Dino Iliopoulos, ILBIB

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