Post by congregatio on Mar 11, 2016 10:24:59 GMT 4
The Canadian Income Tax Act levies income tax on the worldwide income of resident Canadians. Multinational business structures are efficient, from both an operational and financial standpoint, and are often necessary in order to transact with certain entities located outside Canada. However, the practical difficulties associated with monitoring international investment and business activities cause headaches for Revenue Canada. To help combat this issue, the Income Tax Act requires Canadian taxpayers to report income that stems from, or assets situated in, a foreign jurisdiction. This article will focus on the obligation of Canadian taxpayers to file form T1134 with CRA with respect to the active foreign affiliates of the taxpayer, the consequences of failing to do so and the exemptions available to what are becoming fairly onerous reporting requirements.
The T1134 Reporting Obligation
Subsection 233.4(4) of the Income Tax Act mandates that each "reporting entity" file a prescribed form "in respect of each foreign affiliate of the entity. "Reporting entity" is defined in paragraph 233.3(1)(a) to include a resident taxpayer "of which a non-resident corporation is a foreign affiliate at any time in the year". Under subsection 95(1) of the Tax Act, a corporation outside Canada is a foreign affiliate of a resident taxpayer if:
The taxpayer's equity percentage in the corporation is 1% or greater; and
The equity percentages of the taxpayer and each "person" related to the taxpayer total to 10% or greater.
The definition is meant to catch circumstances in which a single taxpayer has a 10% or greater interest in a foreign corporation, or where a taxpayer and related parties (discussed below) combine to have a 10% or greater interest in a foreign corporation. Subsection 248(1) of the Tax Act defines "person" to include a corporation, and that the definition of "related persons" in subsection 251(2) of the Income Tax Act includes not only relations by virtue of blood, marriage, common law partnership or adoption, but also situations where corporations are controlled by individuals that are related to one another. The rules relating to foreign affiliates and related persons under the Tax Act are expansive and for the purposes of this article it suffices to say that related individuals cannot easily circumvent the provisions of the Income Tax Act by using the corporate form.
The form that has to be filled out and submitted by each reporting entity is Revenue Canada's T1134 "Information Return Relating to Controlled and Not-Controlled Foreign Affiliates". Form T1134 requires the reporting entity to provide CRA with information about the foreign affiliate, including but not limited to: the book value of the shares in the foreign affiliate owned by reporting entity, any amounts owing to the foreign affiliate by the reporting entity and vice-versa, consolidated financial statements of the foreign affiliate (if available), total assets of the foreign affiliate, net income of the foreign affiliate, and taxes paid or payable by the foreign affiliate on account of its net income, the breakdown of the foreign affiliate's income and whether the foreign affiliate earned any foreign accrual property income (FAPI), during the reporting period. Completion of the T1134 is an arduous task that requires a detailed analysis of a foreign affiliate's financial position and business activities, which almost certainly requires the assistance of one of our expert Toronto tax lawyers.
Penalties for Failure to File Form T1134 When Required
Failure to file form T1134 when required carries significant penalties on an escalating scale. The simple failure to file form T1134, regardless of intent or knowledge, carries with it a penalty of $2,500 for each year the form is not filed according to subsection 162(7) of the Income Tax Act. Under subsection 162(10) of the Tax Act, every person or partnership who "knowingly or under circumstances amounting to gross negligence" fails to file a T1134 as and when required is liable to a penalty of $500 per month up to a maximum of 24 months, or $12,000, for each failure to file form T1134. Further, if more than 24 months have passed since form T1134 was required to be filed with CRA, and the conditions of subsection 162(10) are met, under subsection 162(10.1) of the Income Tax Act the penalty is equal to 5% of the "greatest of all amounts each of which is the total of the cost amounts to the person or partnership at any time in the year or period of a property of the person or partnership that is a share of the capital stock or indebtedness of the affiliate". So you can see that the penalties for failing to file form T1134 are significant and have the potential to cripple a taxpayer's operations, especially if several years worth of failure to file penalties are levied following a CRA audit.
Exemptions to the Reporting Obligation
There are exemptions to the requirement to file form T1134 with Revenue Canada. Individuals, which are defined to exclude corporations in subsection 248(1) of the Tax Act, do not have to file a T1134 for the year in which they first became resident. This does not include a situation where a former resident becomes a resident of Canada following a period as a non-resident.
In addition to the above, a taxpayer is not required to file form T1134 if the aggregate cost amount to the taxpayer of its interest in all of the foreign affiliates of the taxpayer is less than $100,000 and the particular foreign affiliate is "dormant" during the reporting period. For the purposes of form T1134, a dormant foreign affiliate is one that:
Had gross receipts (including proceeds from the disposition of property) of less than $25,000, and
At no time in the year had assets with a total fair market value of more than $1,000,000.
The information portion of form T1134 explains that the term "gross receipts" means "any receipt received in the year" and "includes all non-revenue receipts, such as loans, etc." As can be inferred by the term, whether or not a foreign affiliate is "dormant" is more a question of its level of activity and has nothing to do with revenue or profitability. Note that the question of dormancy is not relevant when the aggregate cost of the taxpayer's interests in foreign affiliates is $100,000 or more and in such a case form T1134 must be filed with CRA.
By making the fair market value, and not the cost, of the foreign affiliate's assets the relevant consideration when determining whether or not the particular foreign affiliate is "dormant", form T1134 leaves room for uncertainty: while taxpayers can reasonably be expected to keep track of the cost value of the assets of a foreign affiliate, fair market value, by definition, is often not readily ascertainable until assets are sold to arm's length parties on the open market. In Desmarais v The Queen, 2013 TCC 356, this uncertainty worked in favour of a taxpayer who failed to file T1134-A (a predecessor to the modern form T1134) in respect of a foreign affiliate of the taxpayer. In Desmarais, CRA reassessed the taxpayer (an individual) in 2010 for the 2003 and 2004 taxation years, in order to levy penalties against the taxpayer under subsection 162(7) of the Income Tax Act because the taxpayer had allegedly failed to file form T1134-A with the Minister in respect of a foreign affiliate of the taxpayer. Since the reassessment was far beyond the normal three-year reassessment period, in other words statute barred, in order to "open up" the 2003 and 2004 taxation years for reassessment, the Minister was required by subparagraph 152(4)(a)(i) of the Tax Act to show that the taxpayer had made a representation "attributable to neglect, carelessness or wilful default" when he failed to file form T1134-A for the 2003 and 2004 taxation years. The corporate structure was as follows:
The taxpayer owned 29% of the shares of a non-resident corporation, "OREX";
OREX owned approximately 49% of the shares of another corporation, "AIMO";
AIMO owned 20% of the shares of a Russian corporation, "Okhotsk".
On June 30, 2006 AIMO sold its 429 shares in Okhotsk for $7,500,000 (USD) and it was on this basis that CRA argued that the fair market value of OREX's investment in AIMO was worth more than $1,000,000 (CAD) during the 2003 and 2004 taxation years and that therefore OREX was not a "dormant" foreign affiliate according to the definition on form T1134-A. The taxpayer argued, to the contrary, that OREX was in fact "dormant" and provided the following evidence:
The financial statements of OREX listed the book value of its investment in AIMO at one Swiss Franc as December 31, 2002; and
AIMO's financial statements for the 2003 and 2004 taxation years listed the book value of the 429 shares it owned in Okhotsk at $3,689.
The Tax Court of Canada allowed the taxpayer's appeal, and vacated the assessments, because "the market value of AIMO's investment in Okhotsk was only really determined at the time of the redemption, in August 2006, of the 429 shares for US$7,500,000, and it was not until then that it became possible to establish with some degree of certainty the fair market value of OREX's investment in AIMO". Essentially, because there was no certainty as to the value of OREX's investment in AIMO during 2003 and 2004, the taxpayer did not make any misrepresentation "attributable to neglect or wilful default" by failing to file form T1134-A, and that therefore Revenue Canada did not meet the evidentiary burden required to allow the Minister reassess the taxpayer in Desmarais outside the normal three-year period. The Desmarais case is an example of issues that can arise when a reporting requirement is based on the fair market value, and not the cost, of an asset held by a foreign affiliate, as fair market value is often only evident when the asset is disposed of, whether by the specific taxpayer or another holder of the asset. It seems as if, in Desmarais, Revenue Canada was attempting to either make an example of the taxpayer or establish a precedent for levying penalties under subsection 162(7) of the Tax Act: reassessing statute-barred taxation years, in addition to litigating in Tax Court, for the sake of assessing $5,000 worth of penalties is not logical when viewed in isolation.
Voluntary Disclosure for Failure to File Form T1134 by Canadian tax lawyers
The reporting obligation of taxpayers to file form T1134 is complicated, often requiring a detailed analysis of the provisions of the Canadian Tax Act by one of our top Canadian tax lawyers. Taxpayers who have not filed T1134 as required may be eligible for Revenue Canada's Voluntary Disclosures Program if:
CRA has not contacted you about the failure to file form T1134;
At least one year has passed since you were required to file the form T1134;
The failure to file form T1134 is subject to a penalty; and
The voluntary disclosure identifies all areas of the taxpayer's non-compliance with the Income Tax Act.
If the above pre-requisites are met, a taxpayer has a strong chance of making a successful voluntary disclosure to CRA for the failure to file form T1134 as and when required. A successful voluntary disclosure completely eliminates penalties, removes the possibility of criminal prosecution and often offers partial interest relief on any taxes that may be owing. Failed reporting obligations under the Tax Act are ideally suited for the voluntary disclosures program: the penalties are severe and taxes owing are often minimal or nil.
Conclusion – T1134 Requirements
The historically popular exercise of moving assets and operations outside Canada, often in attempts to reduce domestic income taxes owing by enjoying lower income tax rates in offshore jurisdictions, now comes with the increasingly onerous reporting requirements imposed by subsection 233.4(4) of the Income Tax Act and, by extension, form T1134. Significant penalties can and will be charged to taxpayers who do not meet their obligation to file form T1134 with Revenue Canada if and when required.
There are exemptions to the T1134 reporting requirement, but even the exemptions often require taxpayers to be vigilant in their record-keeping and accurate in conducting valuations of their foreign affiliates, tasks that can be overwhelming for individuals and small, privately-held corporations. Our top Toronto tax lawyers are experts on CRA's Voluntary Disclosures Program and can accurately determine whether you have to file a T1134 with respect to your foreign affiliates. If we determine you are not current with your obligation to file form T1134 with CRA, our Toronto tax lawyers firm can help you get compliant with the Income Tax Act by filing a Voluntary Disclosure with CRA to eliminate any possible penalties or prosecution, and to reduce interest on any unreported income owing on account of your foreign affiliates.
The T1134 Reporting Obligation
Subsection 233.4(4) of the Income Tax Act mandates that each "reporting entity" file a prescribed form "in respect of each foreign affiliate of the entity. "Reporting entity" is defined in paragraph 233.3(1)(a) to include a resident taxpayer "of which a non-resident corporation is a foreign affiliate at any time in the year". Under subsection 95(1) of the Tax Act, a corporation outside Canada is a foreign affiliate of a resident taxpayer if:
The taxpayer's equity percentage in the corporation is 1% or greater; and
The equity percentages of the taxpayer and each "person" related to the taxpayer total to 10% or greater.
The definition is meant to catch circumstances in which a single taxpayer has a 10% or greater interest in a foreign corporation, or where a taxpayer and related parties (discussed below) combine to have a 10% or greater interest in a foreign corporation. Subsection 248(1) of the Tax Act defines "person" to include a corporation, and that the definition of "related persons" in subsection 251(2) of the Income Tax Act includes not only relations by virtue of blood, marriage, common law partnership or adoption, but also situations where corporations are controlled by individuals that are related to one another. The rules relating to foreign affiliates and related persons under the Tax Act are expansive and for the purposes of this article it suffices to say that related individuals cannot easily circumvent the provisions of the Income Tax Act by using the corporate form.
The form that has to be filled out and submitted by each reporting entity is Revenue Canada's T1134 "Information Return Relating to Controlled and Not-Controlled Foreign Affiliates". Form T1134 requires the reporting entity to provide CRA with information about the foreign affiliate, including but not limited to: the book value of the shares in the foreign affiliate owned by reporting entity, any amounts owing to the foreign affiliate by the reporting entity and vice-versa, consolidated financial statements of the foreign affiliate (if available), total assets of the foreign affiliate, net income of the foreign affiliate, and taxes paid or payable by the foreign affiliate on account of its net income, the breakdown of the foreign affiliate's income and whether the foreign affiliate earned any foreign accrual property income (FAPI), during the reporting period. Completion of the T1134 is an arduous task that requires a detailed analysis of a foreign affiliate's financial position and business activities, which almost certainly requires the assistance of one of our expert Toronto tax lawyers.
Penalties for Failure to File Form T1134 When Required
Failure to file form T1134 when required carries significant penalties on an escalating scale. The simple failure to file form T1134, regardless of intent or knowledge, carries with it a penalty of $2,500 for each year the form is not filed according to subsection 162(7) of the Income Tax Act. Under subsection 162(10) of the Tax Act, every person or partnership who "knowingly or under circumstances amounting to gross negligence" fails to file a T1134 as and when required is liable to a penalty of $500 per month up to a maximum of 24 months, or $12,000, for each failure to file form T1134. Further, if more than 24 months have passed since form T1134 was required to be filed with CRA, and the conditions of subsection 162(10) are met, under subsection 162(10.1) of the Income Tax Act the penalty is equal to 5% of the "greatest of all amounts each of which is the total of the cost amounts to the person or partnership at any time in the year or period of a property of the person or partnership that is a share of the capital stock or indebtedness of the affiliate". So you can see that the penalties for failing to file form T1134 are significant and have the potential to cripple a taxpayer's operations, especially if several years worth of failure to file penalties are levied following a CRA audit.
Exemptions to the Reporting Obligation
There are exemptions to the requirement to file form T1134 with Revenue Canada. Individuals, which are defined to exclude corporations in subsection 248(1) of the Tax Act, do not have to file a T1134 for the year in which they first became resident. This does not include a situation where a former resident becomes a resident of Canada following a period as a non-resident.
In addition to the above, a taxpayer is not required to file form T1134 if the aggregate cost amount to the taxpayer of its interest in all of the foreign affiliates of the taxpayer is less than $100,000 and the particular foreign affiliate is "dormant" during the reporting period. For the purposes of form T1134, a dormant foreign affiliate is one that:
Had gross receipts (including proceeds from the disposition of property) of less than $25,000, and
At no time in the year had assets with a total fair market value of more than $1,000,000.
The information portion of form T1134 explains that the term "gross receipts" means "any receipt received in the year" and "includes all non-revenue receipts, such as loans, etc." As can be inferred by the term, whether or not a foreign affiliate is "dormant" is more a question of its level of activity and has nothing to do with revenue or profitability. Note that the question of dormancy is not relevant when the aggregate cost of the taxpayer's interests in foreign affiliates is $100,000 or more and in such a case form T1134 must be filed with CRA.
By making the fair market value, and not the cost, of the foreign affiliate's assets the relevant consideration when determining whether or not the particular foreign affiliate is "dormant", form T1134 leaves room for uncertainty: while taxpayers can reasonably be expected to keep track of the cost value of the assets of a foreign affiliate, fair market value, by definition, is often not readily ascertainable until assets are sold to arm's length parties on the open market. In Desmarais v The Queen, 2013 TCC 356, this uncertainty worked in favour of a taxpayer who failed to file T1134-A (a predecessor to the modern form T1134) in respect of a foreign affiliate of the taxpayer. In Desmarais, CRA reassessed the taxpayer (an individual) in 2010 for the 2003 and 2004 taxation years, in order to levy penalties against the taxpayer under subsection 162(7) of the Income Tax Act because the taxpayer had allegedly failed to file form T1134-A with the Minister in respect of a foreign affiliate of the taxpayer. Since the reassessment was far beyond the normal three-year reassessment period, in other words statute barred, in order to "open up" the 2003 and 2004 taxation years for reassessment, the Minister was required by subparagraph 152(4)(a)(i) of the Tax Act to show that the taxpayer had made a representation "attributable to neglect, carelessness or wilful default" when he failed to file form T1134-A for the 2003 and 2004 taxation years. The corporate structure was as follows:
The taxpayer owned 29% of the shares of a non-resident corporation, "OREX";
OREX owned approximately 49% of the shares of another corporation, "AIMO";
AIMO owned 20% of the shares of a Russian corporation, "Okhotsk".
On June 30, 2006 AIMO sold its 429 shares in Okhotsk for $7,500,000 (USD) and it was on this basis that CRA argued that the fair market value of OREX's investment in AIMO was worth more than $1,000,000 (CAD) during the 2003 and 2004 taxation years and that therefore OREX was not a "dormant" foreign affiliate according to the definition on form T1134-A. The taxpayer argued, to the contrary, that OREX was in fact "dormant" and provided the following evidence:
The financial statements of OREX listed the book value of its investment in AIMO at one Swiss Franc as December 31, 2002; and
AIMO's financial statements for the 2003 and 2004 taxation years listed the book value of the 429 shares it owned in Okhotsk at $3,689.
The Tax Court of Canada allowed the taxpayer's appeal, and vacated the assessments, because "the market value of AIMO's investment in Okhotsk was only really determined at the time of the redemption, in August 2006, of the 429 shares for US$7,500,000, and it was not until then that it became possible to establish with some degree of certainty the fair market value of OREX's investment in AIMO". Essentially, because there was no certainty as to the value of OREX's investment in AIMO during 2003 and 2004, the taxpayer did not make any misrepresentation "attributable to neglect or wilful default" by failing to file form T1134-A, and that therefore Revenue Canada did not meet the evidentiary burden required to allow the Minister reassess the taxpayer in Desmarais outside the normal three-year period. The Desmarais case is an example of issues that can arise when a reporting requirement is based on the fair market value, and not the cost, of an asset held by a foreign affiliate, as fair market value is often only evident when the asset is disposed of, whether by the specific taxpayer or another holder of the asset. It seems as if, in Desmarais, Revenue Canada was attempting to either make an example of the taxpayer or establish a precedent for levying penalties under subsection 162(7) of the Tax Act: reassessing statute-barred taxation years, in addition to litigating in Tax Court, for the sake of assessing $5,000 worth of penalties is not logical when viewed in isolation.
Voluntary Disclosure for Failure to File Form T1134 by Canadian tax lawyers
The reporting obligation of taxpayers to file form T1134 is complicated, often requiring a detailed analysis of the provisions of the Canadian Tax Act by one of our top Canadian tax lawyers. Taxpayers who have not filed T1134 as required may be eligible for Revenue Canada's Voluntary Disclosures Program if:
CRA has not contacted you about the failure to file form T1134;
At least one year has passed since you were required to file the form T1134;
The failure to file form T1134 is subject to a penalty; and
The voluntary disclosure identifies all areas of the taxpayer's non-compliance with the Income Tax Act.
If the above pre-requisites are met, a taxpayer has a strong chance of making a successful voluntary disclosure to CRA for the failure to file form T1134 as and when required. A successful voluntary disclosure completely eliminates penalties, removes the possibility of criminal prosecution and often offers partial interest relief on any taxes that may be owing. Failed reporting obligations under the Tax Act are ideally suited for the voluntary disclosures program: the penalties are severe and taxes owing are often minimal or nil.
Conclusion – T1134 Requirements
The historically popular exercise of moving assets and operations outside Canada, often in attempts to reduce domestic income taxes owing by enjoying lower income tax rates in offshore jurisdictions, now comes with the increasingly onerous reporting requirements imposed by subsection 233.4(4) of the Income Tax Act and, by extension, form T1134. Significant penalties can and will be charged to taxpayers who do not meet their obligation to file form T1134 with Revenue Canada if and when required.
There are exemptions to the T1134 reporting requirement, but even the exemptions often require taxpayers to be vigilant in their record-keeping and accurate in conducting valuations of their foreign affiliates, tasks that can be overwhelming for individuals and small, privately-held corporations. Our top Toronto tax lawyers are experts on CRA's Voluntary Disclosures Program and can accurately determine whether you have to file a T1134 with respect to your foreign affiliates. If we determine you are not current with your obligation to file form T1134 with CRA, our Toronto tax lawyers firm can help you get compliant with the Income Tax Act by filing a Voluntary Disclosure with CRA to eliminate any possible penalties or prosecution, and to reduce interest on any unreported income owing on account of your foreign affiliates.