New Opportunities for Canadians Investing In and Through Bermuda
New Opportunities for Canadians investing in and through Bermuda
By: Claire M.C. Kennedy and Wesley Novotny
Bennett Jones LLP
The year 2011 brought welcome developments to Canada-Bermuda relations that herald the growth of closer investment ties and enhanced business opportunities between our nations. In December 2011, the Toronto Stock Exchange Group ("TMX") purchased a 16% interest in the Bermuda Stock Exchange ("BSX") and Tom Kloet, CEO of TMX, joined the BSX board. In addition, there have been two notable changes to Canada-Bermuda bi-lateral investment rules that make Bermuda a more attractive investment destination for Canadian capital and expand the opportunities for Canadian companies to use Bermudian subsidiaries to structure their international operations.
The first change was the entry into force on July 1, 2011 of the Canada-Bermuda Tax Information Exchange Agreement ("TIEA"). As a result, Bermuda resident subsidiaries of Canadian corporations now benefit from certain Canadian tax rules previously reserved for subsidiaries resident in countries with which Canada has a full double tax treaty. Notable among these has been Barbados, so the TIEA helps to level the playing field between Bermuda and Barbados as a convenient, tax-efficient jurisdiction for international structuring in a Canadian multi-national group.
The second notable rule change was the addition of the BSX to the list of approved stock exchanges for certain Canadian tax law purposes. This change opens a fresh pool of capital from which Canadians can invest into BSX-listed investments, presenting new opportunities for BSX-listed companies and Canadian investors.
The Canada-Bermuda TIEA
The Canada-Bermuda TIEA follows an international movement towards bi-lateral TIEAs as countries seek effective exchanges of information to address harmful tax practices and promote cooperation in tax matters. Since the late 1990s, the Organization for Economic Co-operation and Development ("OECD") has pushed to expand the use of TIEAs to inhibit aggressive international tax avoidance and tax evasion. In 2002, the OECD released a draft TIEA model, which forms the basis of hundreds of TIEAs signed around the globe, including the Canada-Bermuda TIEA. The financial crisis of 2007/2008 sped the proliferation of TIEAs as many developed countries sought to raise tax revenue and stop what they viewed as aggressive international tax avoidance and evasion.
Bermuda has signaled its continuing commitment to transparency in the international fiscal context through its signature of 28 TIEAs as of December 2011, with approximately 13 of those TIEAs having come into force.
Like other TIEAs, the Canada-Bermuda TIEA provides a formalized method for the tax authorities of the signatory countries to request and obtain information from the other jurisdiction that is relevant to the administration, collection and enforcement of its tax matters. Specifically, the TIEA permits the Canadian or Bermudian tax authority to seek information in the other jurisdiction held by banks, financial institutions or other nominees regarding the ownership of companies, partnerships, trusts and foundations.
There are limited circumstances where a jurisdiction can decline to assist in a request for information. For example, where the request is contrary to public policy, the communications requested are subject to solicitor-client privilege or a similar privilege, if the information would disclose a trade, business, industrial, commercial or professional secret or if the requesting tax authority is seeking information that it is not permitted to seek domestically.
The first TIEA to which Canada is a party came into force on January 1, 2011. Because they are new, there is little practical guidance as to how Canada's tax authority will use Canada's new network of TIEAs or what type of information they will be requesting. It is expected that over the next few years, Canada's TIEAs procedures and practices will become clearer.
Benefits of the TIEA in International Tax Planning for Canadian Multi-national Groups
Under a complex set of rules referred to a the "foreign affiliate" rules (analogous to the US "controlled foreign corporation" or "CFC" rules), dividends paid to a Canadian from a foreign subsidiary out of active business income sourced in a qualifying jurisdiction in which the subsidiary is resident and carrying on business may be received by the Canadian parent free of Canadian tax. There are also deeming rules that extend this treatment to interest earned by a foreign financing affiliate on loans to foreign active business affiliates in the group and to certain other amounts where certain conditions are met. If the active business income and deemed active business income are taxed in the source country at a lower rate of tax than in Canada, as would be the case for Bermuda source earnings, the overall result is to reduce the effective tax rate in the group on such income. In this respect, Canada's system of foreign affiliate taxation is a (partial) exemption system because the earnings can be repatriated without additional Canadian tax (assuming all eligibility conditions are satisfied). This (partial) exemption system can be contrasted with other nations' systems, notably that of the US, which is based on granting credits for foreign taxes paid, generally limiting the benefits to US multi-national groups to a deferral of tax.
Until 2007, only active business income sourced in a tax treaty country could be eligible for the exempt dividend treatment when repatriated to Canada. The 2007 Canadian federal budget announced significant changes to Canada's outbound taxation system and in particular Canada's foreign affiliate rules. As part of this 2007 package of changes, Canada extended some of the benefits available to a foreign affiliate located in a country with which Canada has a tax treaty to also include countries with which Canada has a TIEA. Subsequent to the entry into force of the Canada-Bermuda TIEA, a Bermudian subsidiary of a Canadian corporation carrying on active business in Bermuda can now, assuming a number of other criteria are met, repatriate dividends to Canada without having those dividends subjected to Canadian tax.
The effect of the TIEA is to help level the Canadian tax playing field for outbound Canadian investment to or via Bermuda. For example, this should allow Bermuda to more effectively compete with Barbados, with which Canada has had a tax treaty since 1980 and through which Canadians often make international investments. Bermuda has no corporate tax, which compares favourably to Barbados, which levies a 1% - 2.5% corporate tax on income of international business corporations operating in Barbados. Bermuda is also a convenient destination to reach, with direct connections and relatively short flying times from major North American centres, including Toronto. Bermuda has well developed and professional business services and is well known for its expertise in finance, insurance and reinsurance, which together make Bermuda an attractive destination for doing international business.
A TIEA does not extend all the benefits of a tax treaty, including for example reduced rates of withholding tax on dividends, interest and royalties. Where Bermuda is considered for the establishment of a holding and/or financing company regime in a multi-national group, consideration must also be given to withholding taxes applied by the operating affiliates' jurisdictions.
While careful tax planning is required in the context of any international tax structuring, the Canada-Bermuda TIEA does increase the opportunity for Canadian multi-national groups to use Bermudian structures in their international tax planning.
The naming of the BSX as a "designated stock exchange"
The naming of the BSX as a "designated stock exchange" by the Canadian federal Minister of Finance allows Canadians to hold investments listed on the BSX in their tax deferred retirement savings plans or tax free savings plans. The most commonly known of these types of plans are the Registered Retirement Savings Plan ("RRSP") and the Tax Free Savings Account ("TFSA"). The addition of the BSX as a designated stock exchange expands the investments that can be held by Canadians and opens a fresh pool of capital that can be tapped by BSX-listed companies.
The addition of the BSX as a designated stock exchange also indicates that the Canadian Minister of Finance considers the BSX to be a well-governed, regulated and transparent market, which, together with the TMX's investment in the BSX, signals confidence in Bermuda's financial system and augers well for continued trade and investment between Canada and Bermuda.
Canada and Bermuda have close ties, including a long history of shared cultural experiences and institutions and a shared common law framework. Bermuda and Canada also follow the same accounting standards and thousands of Canadian expatriates live and work in Bermuda. Many Bermudians, including Bermuda's current Premier, have attended Canadian universities for their post-secondary education. These long-standing connections have been enhanced by recent developments, including the TMX's investment in the BSX, the addition of the BSX as an designated stock exchange for Canadian tax purposes and the entry into force of the Canada-Bermuda TIEA, fostering a bi-lateral investment climate that will make Bermuda an increasingly attractive destination for Canadians to consider when structuring their international operations and investing capital.