The exempt surplus rule can make Canada an attractive location in which to set up a holding company. Under this rule any dividends paid by a foreign affiliate to its Canadian parent are exempt from tax if the following conditions are met:
- The foreign affiliate is resident in a country listed in the income tax regulations as a designate country with a tax treaty in force with Canada.
- Dividends are paid out of the foreign affiliate's "exempt surplus"
The "Exempt surplus" is defined as:
- Earnings from active business activities carried out from the affiliate's permanent establishment. (Thus interest earned from the deposit of funds in a bank account does not come within the definition of exempt surplus.)
- Dividends received by the foreign affiliate from the exempt surplus of other affiliates.
Thus dividends remitted to a Canadian parent
by an Irish affiliate which manufactures
goods for export to the UK market and which
enjoys a tax holiday under Irish laws will
not be taxed in the hands of the Canadian
corporate entity. (N.B. A characteristic
of double taxation treaties is to define
certain categories of income as exempt surplus
income which qualifies for tax free repatriation).
Budget
2007 had this to say with regard to the
exempt surplus rule:
"Although
its mismatch with interest deductibility
has been a long-standing problem, the 'exempt
surplus' rule in itself is a key competitive
advantage of the Canadian tax system. The
rule allows a Canadian company to earn business
income through a foreign affiliate in any
tax-treaty country, and bring that income
back to Canada, with no Canadian tax. Since
the only tax on this business income will
be that paid to the foreign country in which
it is earned, the system ensures that Canadian
firms are able to operate on a level playing
field with their foreign competitors.
"With
the proposal above to resolve the interest
deductibility problem, it is no longer necessary
to link the exemption to the presence of
a tax treaty. In the current environment,
it is more appropriate to link the exemption
to the presence of a comprehensive exchange
of information agreement."
"Budget
2007 therefore proposes to extend the exemption
to active business income from non-treaty
jurisdictions as well as treaty countries,
provided those jurisdictions agree to exchange
tax information with Canada. This will give
Canadian firms more scope to expand internationally,
especially into new and emerging markets,
without our tax system imposing additional
costs that could reduce their competitiveness,
while also maintaining tax fairness. It
will also encourage non-treaty jurisdictions
to join in the efforts of Canada and our
treaty partners to control international
tax evasion."
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