This article focuses on the Canadian tax implications

Transcription

1 CANADIAN TAX REVIEW Tax Consequences of Sales of Real Estate Company Shares by a Nonresident Jack Bernstein is with Aird & Berlis LLP in Toronto. This article is based on a presentation by the author at Seminar F of the annual meeting of the International Fiscal Association in Buenos Aires in September This article focuses on the Canadian tax implications for a nonresident of Canada who disposes of shares of a Canadian private or public real estate company (Canco). The article reviews both actual and deemed dispositions, as well as both direct and indirect investments in Canco. It also deals with the disposition of shares of non-canadian private or public corporations owning real property in Canada. Three case studies are reviewed in the analysis: Case study 1: a nonresident has a direct ownership in shares of a Canco that owns real property in Canada. Case study 2: a nonresident owns shares in a holding company, formed outside of Canada, that owns real property in Canada. Case study 3: a nonresident of Canada owns the shares of a holding company, formed outside of Canada that owns the shares of a Canco. Overview of Canadian Rules A nonresident of Canada is subject to tax in Canada on an actual or deemed disposition of taxable Canadian property (a defined term) (Income Tax Act (Canada), paragraph 2(3)(c)). Unless otherwise stated, all statutory references are to the Canadian Income Tax Act (the Act). That disposition may require a section 116 clearance certificate (discussed below), as well as an obligation to file a Canadian tax return. A sale constitutes an actual disposition. A deemed disposition generally occurs on a seizure by a creditor, a gift or bequest, a corporate reorganization, merger, or liquidation, a redemption, or purchase for cancellation of shares. by Jack Bernstein Taxable Canadian Property Taxable Canadian property is defined in subsection 248(1), and includes: (1) real property situated in Canada (paragraph (a)); (2) an interest in a partnership, if at any time in the previous 60 months more than 50 percent fair market value of the partnership property was real property situated in Canada (paragraph (g)); (3) shares of a private company resident in Canada (paragraph (d)); (4) shares of a private company not resident in Canada if, at any time in the previous 60 months, (1) more than 50 percent of the fair market value of the property of the company (paragraph (e)) consisted of taxable Canadian property and (2) more than 50 percent of the fair market value of the shares is derived from real property situated in Canada; (5) shares of a Canadian public company listed on a prescribed stock exchange if the nonresident shareholder alone or with non-arm slength parties, at any time in the previous 60 months, owned at least 25 percent of the issued shares of any class of the company s stock (paragraph (f)); (6) shares of a non-canadian public company listed on a prescribed stock exchange if, at any time in the previous 60 months, tests (1) and (2) above are met and the nonresident shareholder alone, or with non-arm s-length parties, owned 25 percent or more of the issued shares of any class (paragraph (f)); and (7) an option to acquire taxable Canadian property is treated as taxable Canadian property (paragraph (l)). An option or interest in a share could include a note or debt instrument that is convertible into a share (see Interpretation Bulletin IT-176R2, para. 3). If a Canadian private company becomes a public company in a transaction that involves a share-forshare exchange or a merger or amalgamation, the shares generally continue to be taxable Canadian Tax Notes International December 5,

2 property, notwithstanding that the nonresident owns less than 25 percent of the shares of any class of the public company. Shares received on a conversion, a share-for-share exchange, or an amalgamation are deemed to be taxable Canadian property if the transferred shares were taxable Canadian property (paragraphs 51(1)(f), 85.1(1)(a), 85(1)(i), and subsection 87(4)). No similar rule applies on a reorganization of capital that qualifies for tax deferred treatment under section 86. Meaning of Term Corporation Canada has classified some foreign entities, based on their corporate characteristics, as corporations for Canadian tax purposes. A corporation is an entity created by law having a legal personality and existence separate and distinct from the personality and existence of those who caused its creation or those who own it. A corporation possesses its own capacity to acquire rights and to assume liabilities. Any rights acquired or liabilities assumed by it are not the rights or liabilities of those who control or own it. As long as an entity has that separate identity and existence, the Canada Revenue Agency (CRA) considers that entity to be a corporation even though under some circumstances or for some purposes the law may ignore some facet of its separate existence or identity. That an entity is a hybrid or a transparency in another jurisdiction as a result of a checkthe-box election or other determination is not relevant for Canadian tax purposes. The shares, if any, of those entities may be regarded as taxable Canadian property if the conditions set out above are met. If the entity does not issue shares, arguably there is no taxable Canadian property (see above) and the treaty provisions on gains from the alienation of shares (described below) should not be applicable. The CRA holds, as set out in Interpretation Bulletin IT-343R and several technical interpretations, that the above definition includes not only corporations sometimes referred to as joint stock companies and limited liability companies, but also the following entities organized under the laws of foreign jurisdictions: Aksjeselskap (A/S or A.S.) (Norway); Aktieselskab (A/S) (Denmark); Aktiebolag (Sweden); Aktiengesellschaft (A.G.); Anpartsselskab (ApS) (Denmark); Anstalt (Liechtenstein); Besloten Vennootschap met berperkte aansprakelijheid (B.V.) (Netherlands and possessions); Compañia Anónima; Foundations; 1 Gesellschaft mit beschränkter Haftung(G.m.b.H. or Ges m.b.h.); Joint Stock Company (Russia) (if not limited life); 2 Kabushiki Kaisha (K.K.) (Japan); Korlatolt Feleossegu Tarsasag (kft) (Hungary); 3 Limitada (Sociedade por quotas) (Portugal); Limited Liability Corporation (U.S.); 4 Naamloze Vennootschap (N.V.) (Netherlands and possessions); Sharikat Al-Mossahamah (Saudi Arabia); Sharikat Mussahama; Sherkat Sahami Aam (Iran); Sherkat Sahami Khas (Iran); Sociedad(e)(s) anómina(s) (S.A.); Sociedad(e) (anómina) de responsabilid(e) (ad) limitada (por quotas) (S.L.) (S.A.R.L.) (SRL); Société anonyme; Société de personnes à responsabilité limitée; Société à responsabilité limitée; Société par actions simplifiée (France); 5 Società per Azioni (Italy); Society with Restricted Liability (SRL) (Barbados); and Yugen Kaisha (Japan). Many of the above entities exist in more than one country. Those that the CRA recognizes in one country only are identified by the name of the country in parentheses. Tax Treaties Although Canada has an extensive treaty network, there is no treaty exemption for capital gains realized on Canadian real estate or from the disposition of shares of a private corporation whose value 1 Technical Interpretation no , dated July 25, 1995, states that it is possible that a Dutch foundation (Stichtung, Administratiekantoor) is a corporation. Technical Interpretation concluded that a Fondation du Liechstenstein is a corporation. 2 Technical Interpretation no , dated Jan. 28, Technical Interpretation no , dated Feb. 10, See, e.g., Technical Interpretation no , dated June 30, Advance Tax Ruling December 5, 2005 Tax Notes International

3 is derived primarily from Canadian real estate. 6 As indicated above, Canada s domestic law affords Canada the right to tax those gains. Canada has included in its tax treaties specific provisions to assimilate the sale of shares of a company whose value is derived principally from real property in Canada to the alienation of that property. There is no treaty exemption for capital gains realized on Canadian real estate or from the disposition of shares of a private corporation whose value is derived primarily from Canadian real estate. Article XIII(1) of the Canada-U.S. tax treaty provides that gains derived by a resident of a contracting state from the alienation of real property in the other contracting state may be taxed in that other state. Alienation of property could include the sale or exchange of property, partial alienation, transfers to a company in exchange for stock, a gift, or the bequest of property on death. Article XIII (3)(b) of the Canada-U.S. treaty confirms that real property in Canada includes a share in the capital stock of a company resident in Canada, the value of whose shares is derived principally from real property in Canada. The technical explanation to that provision confirms that the term principally means more than 50 percent. Taxation in Canada is preserved through several tiers of entities if the value of the company s shares or the partnership, trust, or estate ultimately depends principally on real property situated in Canada. Article 13(5) of the Canada-U.K. tax treaty enables a contracting state to tax gains from the alienation of shares, other than shares quoted on an approved stock exchange, deriving their value or the greater part of their value directly or indirectly from immovable property in a contracting state. Article 13(6) provides an exemption for a shareholder owning less than 10 percent of the shares. Article 13(4) of the OECD model tax convention provides that gains from the alienation of shares driving more than 50 percent of their value directly or indirectly from immovable property situated in a contracting state may be taxed in that state. There are unresolved valuation issues. For example, if a corporation owns real property and carries on another business, do you reduce the value of the real estate by any related liabilities in determining whether more than 50 percent of the value of the shares is derived from real property? Assume that a corporation owned real estate having a fair market value of C $50 million subject to a mortgage of C $35 million and shares of an operating company having a fair market value of C $20 million. Clause 28.4 of the OECD commentary specifically provides that value is determined without taking into account debts or other liabilities of the company (whether or not secured by mortgages on the relevant immovable property). CRA generally follows the OECD commentary, except when Canada has specifically entered a reservation. 7 There is no reservation by Canada on that provision. As indicated above, the definition of taxable Canadian property includes shares of a corporation resident outside of Canada that derives its value principally from real property in Canada. The fifth protocol to the Canada-U.S. income tax convention provides an exemption from Canadian tax for gains realized by a U.S. resident on the disposition of shares of a non-canadian company that derives its value principally from real property in Canada. The treaty exemption does not apply to a U.S. LLC unless it elects to be treated, for domestic purposes, as a corporation. The CRA takes the position that an LLC is not a resident under the treaty as it is not liable to taxation. Arguably, treaties such as those with Switzerland and Germany, which refer only to shares of a company resident in Canada, prevent Canada from taxing the shares of a corporation resident outside of Canada that derives its value principally from real property in Canada. Some treaties exempt shares in publicly traded companies the value of which is derived principally from immovable property. (See Algeria, Austria, Belgium, Bulgaria, Croatia, Estonia, Germany, Hungary, Iceland, Ireland, Italy, Kazakhstan, Kuwait, Kyrgyzstan, Latvia, Lebanon, Lithuania, Luxembourg, Mexico, the Netherlands, Slovenia, South Africa, Sweden, Switzerland, Tanzania, Ukraine, the United Kingdom, Uzbekistan, and Venezuela.) The treaty exemption overrides the Act. No section 116 clearance certificate (as discussed below) is required on a disposition of shares listed on a 6 Many treaties provide relief for shareholders owning less than 10 percent of the shares. Article 13, paragraph 6 of the Canada-U.K. treaty provides an exemption for a shareholder owning less than 10 percent of the shares. Article 13 of the treaties with Germany and Switzerland contains a similar exemption. 7 See, e.g., The Queen v. Crown Forest Industries, 95DTC 5389 (SCC); Pacific Network Services Ltd. v. MNR, 2002 DTC 7585 (FCTD); McFayden v. The Queen, 2003 DTC 5015 (FCA). Tax Notes International December 5,

4 prescribed stock exchange. Technically, a Canadian tax return should be filed (discussed below) to claim the treaty exemption. Section 116 Clearance Certificate Section 116 of the Act requires a nonresident vendor to apply for a clearance certificate either before or within 10 days after a disposition of taxable Canadian property other than excluded property. A vendor who fails to comply or makes false representations may be subject to prosecution (subsection 238(1)). The objective is to ensure that nonresidents comply with their obligation to report the transaction. An application must be made even if a treaty exemption is available. If a foreign partnership owns shares that are taxable Canadian property, one notice of disposition may be filed on behalf of all partners. A person who is resident in a country, other than Canada, under the provisions of a bilateral tax treaty with Canada is deemed to be a nonresident of Canada for Canadian tax purposes (subsection 250(5)). The certificate procedure applies to a sale of taxable Canadian property, other than excluded property, by a nonresident to either a resident or to a nonresident of Canada. There are practical enforcement problems if shares of a corporation not resident in Canada are sold by one nonresident to another nonresident. If the vendor is a Canadian resident before the disposition, but will be a nonresident at the time of disposition, a section 116 certificate is required. No clearance certificate is required for shares listed on a prescribed stock exchange (paragraph 116(6)(b)). It can take six weeks or longer to obtain the certificate. The CRA will provide comfort letters when an application has been made but a certificate of compliance cannot be issued before the closing of the transaction. If a comfort letter is issued, the purchaser is required to withhold 25 percent of the purchase price and may wait for the certificate to be issued without being liable for penalties or interest. Form T2062 must be completed in connection with a proposed disposition of shares of companies. The nonresident must provide the name and address of both the vendor and the purchaser, a description of the property, the estimated or actual proceeds, and the tax cost (adjusted cost base) of the taxable Canadian property. Treaty relief, if available, is claimed on the application, and proof of residency is required. If a foreign partnership owns shares that are taxable Canadian property, one notice of disposition may be filed on behalf of all partners. That must include a complete listing of the nonresident partners, their addresses, tax identification, and payment of the tax or security for the payment of tax. For a sale of shares, Canadian tax or appropriate security must be remitted or provided with the application equal to 25 percent of the amount of the gain. The outlays and expenses relating to the sale are not taken into account in computing tax payable for the certificate, but would be deducted when the tax return is filed, and a refund may be available (Information Circular IC72-17R5, para. 35). Form T2064 is the clearance certificate issued by the minister of revenue for a proposed disposition and Form T2068 is the clearance certificate for an actual disposition. The certificate sets out a certificate limit based on the reported proceeds. A second certificate may be required if there is a change in the identity of the purchaser, the price is increased, or the tax cost is lower than on the original certificate (subsection 116(3) and (4)). A payment of the additional tax is required and a certificate of compliance will be issued (Form T2068). The purchaser has an obligation to make a reasonable inquiry as to whether the vendor is a nonresident of Canada. A boiler plate clause in all Canadian agreements on sales of shares of Canadian private companies or real estate in Canada is that the vendor will not be a nonresident of Canada at the time of closing. Once the vendor is indicated to be a nonresident, the purchaser will require that the vendor obtain a section 116 clearance certificate. The receipt of a clearance certificate with a certificate limit not less than the purchase price relieves the purchaser of liability (subsection 116(4)). The clearance certificate must identify the taxpayer, the actual proceeds of disposition, and the tax cost (adjusted cost base), and will not be issued unless the tax has been paid or security provided. The issuance of the certificate when a treaty exemption is claimed is discretionary. (See Information Circular IC72-17R5, para. 28.) If the CRA is concerned about abusive planning (for example, Canadian residents own shares of a nonresident company or it is impossible to identify the beneficial owners, for instance, when a widely held partnership owns the shares of a nonresident company), the certificate may not be issued. If no certificate is provided to the purchaser at closing, or if the certificate amount is less than the purchase price, the purchaser must withhold and, within 30 days after the end of the month in which the disposition occurred, remit to the CRA 25 percent of the gross proceeds. There is a penalty for late payment (subsection 227(9)). Failure to withhold when no certificate is obtained renders the purchaser liable for 25 percent of the gross proceeds 886 December 5, 2005 Tax Notes International

5 plus interest and a penalty of 10 percent of the amount required (subsection 116(5) and 227(10.1)). There is a penalty for late payment (subsection 227(9)). The purchaser has an obligation to withhold and remit 25 percent of the difference between the actual sale price and the certificate limit obtained by the vendor (that is, when the vendor s clearance certificate understates the purchase price). This will exceed the amount of tax payable by the nonresident as it is computed based on the proceeds rather than on the gain or loss (in other words, the tax is computed without taking into account the nonresident vendor s tax basis in the property). The purchaser can be liable for 50 percent of the amount of the gross proceeds when there is a direct sale of real property that is not capital property to the nonresident vendor (that is, it is real estate inventory to the nonresident) and no section 116 clearance certificate is obtained. Similarly, if the amount shown in the clearance certificate is less than the purchase price, the purchaser will be liable for 50 percent of the amount by which the purchase price for the real estate inventory exceeds the amount shown in the certificate. The exercise of a warrant to acquire shares of a private corporation resident in Canada or the grant by a nonresident of an option or call to acquire those shares or real property in Canada is a disposition of taxable Canadian property, and a clearance certificate is required. However, the issuer of the warrant is not a purchaser under subsection 116(5) and does not have a liability if a certificate is not obtained (Technical Interpretation E5). The nonresident who does not obtain a clearance certificate would have no choice but to file a Canadian tax return, which would be restricted to the gain (or loss) on the disposition of the taxable Canadian property. A refund is available if the tax remitted exceeds the tax payable. Quebec Certificate If the real property is situated in Quebec, there is additional provincial compliance. Section 1094 of the Taxation Act (Quebec) contains a definition of taxable Quebec property and a similar certificate procedure. Section 1101 of the Taxation Act requires a vendor to pay a tax in Quebec equal to 12 percent of the gain. If no certificate is obtained, a purchaser must withhold an amount equal to 12 percent of the proceeds. The gain may be exempt if an income tax convention provides relief. There are some differences. For example, while a nonresident corporation must obtain a certificate on the disposition of taxable Quebec property, a nonresident individual only requires a certificate on a sale of real property situated in Quebec and does not require a certificate for the disposition of shares of a resident or a foreign company. Another difference is that a certificate is required for all deemed dispositions, including death. (See Interpretation Bulletin IMP /R1, Jan. 31, 1995.) Dispositions The Act contemplates both actual and deemed dispositions. A disposition is any transaction or event that entitles a taxpayer to proceeds of disposition. A gift of shares that are taxable Canadian property is deemed a disposition at fair market value and requires a clearance certificate (subsection 116(5.1)). A sale of taxable Canadian property (other than excluded property) between related parties is deemed to result in proceeds of disposition to the vendor equal to the fair market value of the property (subsection 116(5.1)). Expenses relating to a sale do not reduce the tax for purposes of the section 116 certificate, but may be claimed on the tax return. Death or mortgage foreclosure (considered deemed distributions) do not require a clearance certificate. (See Interpretation Bulletin IT-150R2, para. 2 and 3, archived.) The exercise of a power of sale does require a section 116 certificate if the debtor is a nonresident. A seizure by a creditor of shares pledged would also require a certificate. Although a section 116 certificate may be required, there may be no gain if the capital of Canco were reorganized in accordance with section 86 or in connection with a share-for-share exchange that qualified for tax-deferred treatment under section 85(1) or 85.1 of the Act. If shares are converted into shares of another class of the same corporation under a conversion feature, there is no disposition for the nonresident under section 51. However, the CRA has taken the position that the purchaser (the Canadian corporation) is considered to acquire shares that are taxable Canadian property. CRA will issue a comfort letter to the Canadian corporation indicating that withholding is not required and that interest and penalties will not apply (CCH Tax Topics Report no. 1576, dated May 23, 2002). A section 116 certificate is not required on an amalgamation. (See Interpretation Bulletin IT-474R para. 50.) A foreign merger would require a section 116 certificate, but subsection 87(8) may provide relief if the merger is a result of a tax-free reorganization in another country that qualifies under subsection 87(8.1). A foreign merger generally includes a merger or combination of two or more Tax Notes International December 5,

6 corporations resident outside of Canada to form one corporation resident outside of Canada (subsection 87(8.1)). If the corporate law applicable to a merger is of a continuation type as described by the Supreme Court in The Queen v. Black and Decker Manufacturing Co. Limited, (1974) 43 D.L.R. (3d) 393, there would be no disposition and no requirement for a section 116 certificate. (See Technical Interpretation , Apr. 10, 2003.) A redemption or purchase for cancellation of shares of a foreign company is a disposition and would give rise to a capital gain for Canadian tax purposes if the proceeds exceed the tax cost for Canadian purposes of the shares. That disposition of taxable Canadian property, other than excluded property, would require a clearance certificate. A redemption or purchase for cancellation of shares of a Canadian corporation triggers a deemed dividend equal to the difference between the proceeds of disposition for the share and the paid-up capital of the share (generally the subscription price paid to the corporation for all the shares of the particular class divided by the number of shares of the class issued and outstanding) (subsection 84(3)). The deemed dividend is subject to Canadian withholding tax at 25 percent, unless reduced by a treaty (subsection 212(2)). If a treaty is available, the rate of Canadian withholding tax on a dividend generally is reduced to 5 percent (generally when the recipient is a corporation that holds a minimum of 10 percent of the voting shares) or 15 percent in other cases, which is lower than the 25 percent rate on a disposition of taxable Canadian property. The payer has the obligation to withhold the tax on the amount of the deemed dividend, and no preapproval is required from the CRA (unlike for the clearance certificate). However, the nonresident is considered to dispose of the shares for an amount equal to the proceeds of disposition less the amount of the deemed dividend. A capital gain is possible if the paid-up capital of the shares exceeds the tax cost (adjusted cost case) of the shares. A section 116 certificate is required for the disposition of the shares even when the shares are redeemed, acquired, cancelled, or otherwise repurchased by the issuing corporation. Tax Returns The final settlement of tax on the disposition of taxable Canadian property occurs when the vendor s income tax return is finally assessed. The tax return must be filed for the taxation year in which the disposition occurred (section 150). The tax return is required even if the shares are excluded property and no section 116 clearance certificate was required. Any excess payment is refunded or provision is made for the release of security once all tax owed has been paid. As indicated above, expenses relating to a sale do not reduce the tax for purposes of the section 116 certificate, but may be claimed on the tax return. An individual must file a Canadian tax return on or before April 30 of the calendar year following the year in which the disposition occurred. There is an exclusion if the nonresident individual only had a gain from the disposition of taxable Canadian property (subparagraph 150(1.1)(b)(iii)). A trust must file a Canadian tax return within 90 days after the end of the year in which the disposition occurred. A corporation must file a nonresident return within six months of its fiscal year-end (clause 150(1)(a)(i)(D)). Tax returns are required to be filed by a corporation whether or not a section 116 clearance certificate has been obtained. There is a penalty for not filing a corporate return. Other Taxes There are no Canadian transfer taxes or sales taxes on a disposition of shares of a Canadian or foreign corporation. Case Study No. 1 Subject to the exceptions noted above, an actual or deemed disposition of shares of Canco would be taxable in Canada and would require both a section 116 clearance certificate (unless the shares of Canco are listed on a prescribed stock exchange) and filing a Canadian tax return. If the property is located in Quebec, a Quebec clearance certificate is required unless the vendor is an individual. There would not be a requirement for a clearance certificate if the shares are transferred under a will. A nonresident shareholder is not taxable in Canada as the shares do not constitute taxable Canadian property if Canco is a Canadian public corporation and the shareholder, together with nonarm s-length persons, owns less than 25 percent of the shares of any class, unless the nonresident shareholder previously transferred shares of a Canadian private company to Canco under a transaction under sections 51 (convertible shares), 85 (transfer to a Canada corporation), 85.1 (share-forshare exchange) or 87 (amalgamation) that results in the shares being deemed taxable Canadian property. No section 116 certificate is required. As indicated above, several treaties provide a capital gains exemption for shares of listed companies. If a treaty exemption is available, a vendor would not be taxable in Canada, notwithstanding that share ownership was 25 percent or more of the shares of any class or that there was a previous transfer of taxable Canadian property. A Canadian tax return should be filed to claim the exemption. A liquidation of a Canadian corporation triggers a deemed disposition at fair market value of the corporate assets and a deemed dividend to the 888 December 5, 2005 Tax Notes International

7 shareholders equal to the difference between the amount distributed to the shareholder and the paid-up capital of the shares held by that shareholder (subsection 88(2)). Canadian withholding tax at 25 percent, unless reduced by treaty, must be withheld on the amount of that deemed dividend realized by a shareholder not resident in Canada. The shares are deemed to be disposed of for proceeds of disposition equal to the amount distributed to the shareholder less the amount of the deemed dividend (54(g)). A capital gain may result if the deemed proceeds exceed the tax cost of the shares. A section 116 certificate is required. A deemed dividend may arise on a redemption or purchase for cancellation of the shares by the corporation. Canadian withholding tax at 25 percent, unless reduced by treaty, would apply to the deemed dividend. There is also a deemed disposition for proceeds equal to the amount distributed to the shareholder less the amount of the deemed dividend. A section 116 clearance certificate is required (and if the property is located in Quebec, a Quebec clearance certificate) unless the shares of the corporation are listed on a prescribed stock exchange. A deemed disposition occurs on the death of a shareholder (subsection 70(5)), a transfer of shares of Canco by a nonresident trust to a beneficiary (subsection 107(5)), a seizure by a creditor or a share reorganization or merger of Canco (although it would not be taxable if the reorganization or merger qualifies as a tax-deferred transfer under section 51 (convertible shares), 85 (transfer to a Canadian corporation), 85.1 (share-for-share exchange), 86 (share reorganization), or 87 (amalgamation) of the ITA). No section 116 certificate is required on death, a share conversion under section 51, or on an amalgamation. The exercise of an option by a nonresident to acquire the shares of Canco or the exercise of a warrant to acquire shares of Canco is treated as a disposition of taxable Canadian property, and a section 116 certificate is required. A return is required to be filed if the nonresident vendor is not an individual. There is no Canadian transfer or sales tax on a disposition of shares. Case Study No. 2 An initial determination must be made if the shares of the foreign or nonresident holding corporation (Holdco) are taxable Canadian property. That test is satisfied if the shares of Holdco being disposed of are not listed on a prescribed stock exchange and if at any time in the 60-month period ending at the time of disposition: (1) more than 50 percent of the fair market value of Holdco s property consists of taxable Canadian property, and (2) more than 50 percent of the fair market value of the Holdco shares disposed of is derived from Canadian real property. If the class of shares of Holdco being sold is listed on a prescribed stock exchange, the nonresident shareholder, together with non-arm s-length parties, must have owned at least 25 percent of the issued shares of any class at any time in the previous 60 months (or previously transferred shares that were taxable Canadian property to Holdco). Tests (1) and (2) above must also be met. If the shares of Holdco are listed, there may be relief from Canadian tax under a relevant treaty. (See above.) A U.S. resident (other than an LLC) is exempt from Canadian tax on a disposition of shares of Holdco. If Holdco is a hybrid or transparency in another country, Canada may still characterize Holdco as a corporation for Canadian tax purposes. If the shares of Holdco are taxable Canadian property, the nonresident shareholder is taxable in Canada on an actual or deemed disposition. A Canadian tax return must be filed. Unless the shares of Holdco being disposed of are listed on a prescribed stock exchange or the deemed disposition occurs on death, a section 116 clearance certificate (or if the property is located in Quebec, the Quebec equivalent) is required. There are practical enforcement issues if the shares are transferred to another nonresident. A redemption or purchase for cancellation of shares, or a gift of shares, or a liquidation, merger, or corporate reorganization of Holdco would be a deemed disposition. Unlike a redemption of shares of a Canadian corporation, there is no deemed dividend on the redemption of shares of Holdco. It is treated instead as a capital gain. A foreign share-forshare exchange or a foreign merger may not be taxable if the conditions in subsection 85.1(5) or 87(8) are satisfied or the merger is a continuancetype transaction. A foreign reorganization of capital may not be taxable under section 86. Under the provisions of the Canada-U.S. income tax convention, a U.S. resident (other than an LLC that does not elect to be treated as a corporation) is not taxable in Canada on a disposition of shares of Holdco, although a section 116 certificate is required if the shares of Holdco are not listed on a prescribed stock exchange. As indicated above, a treaty that deals only with shares of a company resident in Canada, such as those with Switzerland and Germany, may preclude Canada from taxing the gain on the disposition of shares of Holdco. There are no Canadian transfer or sales taxes on the disposition of shares. Tax Notes International December 5,

8 Case Study No. 3 The shares of Canco are taxable Canadian property if those shares are not listed on a prescribed stock exchange or if the Canco shares are listed and Holdco alone or together with non-arm s-length parties has at any time in the previous 60 months owned 25 percent or more of any class of the shares of Canco or previously transferred shares of a Canadian private company to Canco. If the shares of Holdco are not listed, the shares are taxable Canadian property if at any time in the previous 60-month period (1) more than 50 percent of the fair market value of all of the properties of Holdco consisted of taxable Canadian property and (2) the shares of Canco are taxable Canadian property and more than 50 percent of the fair market value of the shares of Holdco is derived from the shares of Canco. Under the provisions of the Canada-U.S. income tax convention, a U.S. resident (other than an LLC) is exempt from Canadian tax on a disposition of shares of Holdco; however, a section 116 clearance certificate is required if the shares of Holdco are not listed on a prescribed stock exchange. As indicated above, other treaties, such as those with Switzerland and Germany, may offer protection. If the shares of Holdco are listed on a prescribed stock exchange, a nonresident shareholder is taxable in Canada only if at any time in the previous 60 months: the shareholder together with non-arm s-length parties owned at least 25 percent of any class of the shares of Holdco (or previously transferred shares of a Canadian private company to Holdco in exchange for shares); more than 50 percent of the fair market value of all of Holdco s property consists of taxable Canadian property; more than 50 percent of the fair market value of the shares of Holdco is derived from Canco; and there is no treaty protection. If the shares of Holdco are taxable Canadian property, there is potential Canadian tax on an actual or deemed disposition, including the sale of shares, death of a shareholder, gift of shares, seizure by a creditor, or a corporate reorganization of Holdco, including a share-for-share exchange, merger, or liquidation. Relief may be available if the foreign share-for-share exchange is tax-deferred under subsection 85.1(5), if it qualifies as a reorganization of capital under section 86, or if the foreign merger is tax-deferred under subsection 87(8). A continuance-type transaction may not be a disposition for Canadian tax purposes. Also, the exercise of a conversion privilege to convert a share into another class of shares may not be a disposition under subsection 51(1). A Canadian tax return must be filed. A section 116 clearance certificate is required (and, if the property is located in Quebec, the Quebec equivalent) except for a transfer under a will. 890 December 5, 2005 Tax Notes International