Tax and other policy-related developments
In today’s volatile environment, companies will need to carefully monitor geopolitical, macroeconomic and global tax developments to make sound tax decisions for 2024 and beyond.
Canadian tax policy outlook
Interest and financing expenses limitation rules ("EIFEL")
Anti hybrid arrangements
Mandatory disclosure rules
Amendments to General Anti Avoidance Rule ("GAAR")
Tax on repurchases of equity
Digital Services Tax ("DST")
Canada's Global Minimum Tax Act ("GMTA")
US tax policy outlook
Global tax environment – unprecedented cross-border cooperation
Tax compliance and controversy – driven by data
Over the last few years, the Federal government has released various significant legislative proposals and in 2023 and 2024 we are seeing many of these proposals being enacted and coming into effect. The depth and breadth of these changes in such a short time frame materially affect virtually all taxpayers and are expected to result in an increase in complexity, compliance obligations and/or tax cost for many organizations.
The stated objective of the EIFEL rules is to address concerns arising from taxpayers deducting excessive interest and other financing costs, principally in the context of multinational enterprises and cross-border investments.
In general terms, the EIFEL rules limit the deductibility of net interest and finance expense to 30% of Adjusted Taxable Income (“ATI”) with ATI generally representing EBITDA for tax purposes. The rules are broad, extremely complex and must be analyzed carefully for an organization’s particular fact pattern.
The result of these rules could be an increase in current taxes due to the inability to deduct all or some of the interest/financing costs which in turn may lead to an increase in the after-tax cost of borrowing. For acquisitive organizations this may impact the economics of contemplated deals. Organizations must consider carefully where and how to finance their operations as the historical model often employed in Canada (leveraging the Canadian multinational to finance foreign expansion) may no longer be tax effective.
The EIFEL rules are included in Bill C-59 which is currently in its second reading at the House of Commons. Bill C-59 is expected to be substantively enacted/enacted in 2024 with the EIFEL rules being retroactively applicable to taxation years beginning on or after October 1, 2023. For organizations with a calendar year end, the rules will be applicable for the year starting January 1, 2024, with no grandfathering for existing debt.
On April 29, 2022, the Canadian Government released draft legislative proposals to address certain “hybrid mismatch arrangements”. In general terms, "hybrid mismatch arrangements” are described as cross-border arrangements that exploit differences in the income tax treatment of business entities or financial instruments under the laws of two or more countries that produce mismatches in tax results.
The final version of these proposals is also included in Bill C-59 and as such is expected to be substantively enacted/enacted in 2024. Once enacted these rules will be retroactively effective to July 1, 2022 with no grandfathering for existing arrangements.
Organizations should analyze any existing tax efficient financing structures currently in place to ensure that such structures are not in scope of these rules.
To address a perceived lack of timely, comprehensive and relevant information on aggressive tax planning strategies, the Mandatory Disclosure Rules (“MDR”) were enacted in June of 2023 and apply to taxation years starting after 2022. The MDR rules include the following:
An expansion of the “reportable transaction” rules, requiring the disclosure of transactions where one of the main purposes of such a transaction was to obtain a tax benefit and the transaction includes any one of the following 3 generic hallmarks: contingent fee arrangement, confidential protection or contractual protection.
A tax reporting requirement for taxpayers, promoters and advisors that enter into, promote or advise on a “notifiable transaction”. Notifiable transactions are specific transactions that have been designated by the Minister of National Revenue or transactions that are the same as or substantially similar to such transactions. To date, the CRA has identified 5 designated transactions1.
A new requirement to disclose certain “uncertain tax treatments” recorded in the financial statements of a taxpayer or its related group. This new disclosure requirement applies to corporations that are required to file Canadian corporate income tax returns, had assets of at least $50M CAD in the prior year and issues or is related to a corporation that issues audited financial statements.
Failure to make the required disclosures required by the MDR carries significant adverse consequences such as significant monetary penalties and an extension of the statute barred period in respect to applicable transactions.
Organizations must ensure that they are working closely with their advisors and tax compliance providers to identify any transactions that require disclosure and to make such disclosures on a timely basis.
1 Notifiable transactions designated by the Minister of National Revenue - Canada.ca
On August 4, 2023, draft proposals were released to introduce a 2% tax on the net value of equity repurchases by certain publicly traded entities in Canada, subject to a $1,000,000 de minimis rule and applicable in respect of repurchases and issuances of equity that occur after 2023.
The tax applies to Canadian resident corporations with shares listed on a designated stock exchange (excluding mutual fund corporations), as well as to real estate investment trusts (REITs), specified investment flow-through (SIFT) trusts, SIFT partnerships that have units listed on a designated stock exchange, and certain other publicly traded entities that would be SIFT trusts or SIFT partnerships if their assets were located in Canada. Certain exceptions to the scope of the tax apply, including for debt-like preferred shares and units meeting certain conditions and for shares or units that are issued or cancelled as part of certain types of corporate reorganizations and acquisitions.
The final rules in respect to the tax on repurchases of equity are contained in Bill C-59 and therefore are expected to be substantively enacted/enacted in 2024 and be effective to equity buy backs occurring on or after January 1 2024.
In August of 2023 the Federal government introduced draft legislation to clarify the intention of the GAAR rules, expand and broaden when the GAAR rules may apply and introduce penalty provisions and statute barred implications for transactions that fall under the GAAR.
Organizations must ensure they are working closely with their tax advisors to identify transactions that may now fall within the scope of the new GAAR and assess whether such transactions should be reported to the CRA (in order to avoid the potential application of the penalty provisions and the statute barred extension provisions contained in the new GAAR).
The amendments to GAAR are contained in Bill C-59 and therefore are expected to be substantively enacted/enacted in 2024 and be effective for transactions that occur on or after January 1, 2024.
Canada’s Digital Services Tax rules, which were originally proposed by the Federal government in December of 2021, are included in Bill C-59 and therefore expected to be substantively enacted/enacted in 2024, with an effective date of January 1, 2024.
Although the DST was proposed in 2021, it was designed to only come into force provided that the multilateral measures proposed in Pillar 1 of the OECD/G20’s Inclusive Framework on Base Erosion and Profit Shifting were not yet implemented by the end 2023. OECD’s Pillar 1 efforts have been weakened and stalled for a number of different reasons and therefore Canada has decided to move forward with its unilateral taxation of digital services revenue arising from the Canadian marketplace.
In general terms the DST applies a 3% tax on taxable Canadian digital services revenue in excess of $20 million CAD of large domestic and foreign businesses (total revenue of a consolidated group of which the entity belongs is at least €750 million during a fiscal year that ends in the preceding calendar year).
Organizations that are in scope must ensure they have assessed these rules closely in order to ensure compliance with the DST rules.
As discussed further below, the Global tax environment is seeing an unprecedented level of global coordination, primarily driven by Pillar 2 of the OECD/G20’s Inclusive Framework on Base Erosion and Profit Shifting (the 15% global minimum tax).
The Canadian Federal government has consistently communicated its intention to comply with the requirements of Pillar 2 and in August of 2023, it released a draft of the Global Minimum Tax Act which serves as the Canadian legislation to implement the global minimum tax proposed by Pillar 2.
In general terms, the GMTA aligns with the Pillar 2 Model Rules released by the OECD and levies a tax to ensure that a minimum tax rate of 15% is applied to each jurisdiction in which an organization operates. While the GMTA continues to be in draft form, it is expected that it will be enacted some time in 2024 with an effective date of January 1, 2024.
Please see below for a broader discussion of the implications of the Pillar 2 rules and the various items that should be considered by Organizations expected to be in the scope of such rules.
The political dynamics and unpredictability of the current US Congress have so far yielded little in terms of tax legislation, but it is still possible that a tax bill could advance in early 2024 if a must-pass legislative vehicle, such as a federal government spending bill, emerges. Among the items that might be included are modifications of some expired provisions from the Tax Cuts and Jobs Act (TCJA). These include addressing a change to Section 174 that requires five-year or 15-year research and development (R&D) amortization, depending on the location of the activity, rather than expensing; changes to the interest deduction limitation calculations under Section 163(j); and 100% expensing.
Renewing these expired provisions requires quick action as Congress will now need to change tax laws affecting the current tax year. This dynamic becomes more challenging as the days and months advance. Competing priorities among members of Congress further complicates matters. Congressional Democrats wish to expand the Child Tax Credit, while Republicans would aim to partially offset a tax package’s revenue losses by rolling back clean energy tax provisions from the 2022 Inflation Reduction Act (IRA). Some members of both political parties in high-tax states would also like to enact some form of relief from the TCJA’s $10,000 cap on deductions for state and local taxes (SALT).
Globally, it is a time of fundamental tax change and cross-border coordination that may have profound implications for multinational entities (MNEs) and their global tax obligations. In October 2021, agreement was reached on new global minimum tax rules that establish a minimum tax rate of 15% and give priority of rights to impose a “top-up tax” to the local country, the headquarters country or other countries where an MNE group has taxable presence. Known as Pillar Two of the OECD/G20 project on addressing the tax challenges arising from the digitalization of the economy (commonly referred to as the BEPS 2.0 project), it applies to companies with global revenue of at least €750m and is being implemented through changes to country tax laws.
Among the potential implications of Pillar Two for MNEs:
Increases in cash taxes and effective tax rates
Substantive changes to tax provision and compliance processes, controls, systems and governance
Re-evaluation of legal structures
Increased costs for mergers and acquisitions
The EU adopted a Pillar Two directive at the end of 2022 requiring most Member States to implement the global minimum tax rules by the end of 2023. Many countries in both Europe and Asia are already beginning to implement Pillar Two, and global minimum tax rules will begin to take effect in countries in 2024. Given the variations in implementation within different countries, careful consideration and monitoring of country legislative activity will be important.
The United States, meanwhile, currently has no pending legislation on Pillar Two implementation, however, even if the United States does not adopt the Pillar Two rules, the design of the Pillar 2 rules and the widespread adoption of such rules by other jurisdictions means US entities that are in the scope of these rules will still be materially impacted by them.
To prepare for Pillar Two, potentially affected companies will want to make sure they have the appropriate processes and controls in place, and audit committees should review management’s plans as soon as possible. There will be substantial new data requirements and the need to perform complex calculations. Companies may also need to consider disclosures if Pillar Two is expected to materially impact their tax exposures.
The other part of the OECD/G20 BEPS 2.0 project, Pillar One on new rules for allocating taxing rights to global business profits among countries, is moving forward more slowly. Significant new documents on Pillar One were released on October 11, 2023, and global negotiations are expected to continue into 2024.
The evolving and globally connected tax landscape is also prompting a re-examination of companies’ tax governance and data needs, and the focus on tax controversy is growing. Greater transparency and cross-border cooperation, coupled with expanded access to technology, have increased tax authorities’ expectations for access to company data.
In response, companies need to find ways to make sure their data is “audit-ready.” They should be thinking about how they can transform their approach to tax and financial data management to facilitate accurate and timely responses to new reporting obligations that may arise from BEPS 2.0, emerging environmental, social and governance (ESG) concerns and country-by-country reporting requirements.
Boards and audit committees also need to be mindful of shifts in tax controversy areas of focus. The CRA continues to receive increased funding from the federal government, which has resulted in a notable increase in audit enforcement activity.
