Part 3: KEY TAX IMPLICATIONS ARISING FROM COVID-19 RELIEF
4 Things Your Business Expects You to Know About Tax & Incentives.
When considering the tax effect of government assistance the default is to include the amount received in taxable income whether it be a grant, subsidy, or forgivable loan. Therefore, the following economic stimulus amounts should be included in taxable income, in the period the benefit is realized:
- Canada Emergency Wage Subsidy (CEWS)
- Temporary 10% Wage Subsidy
- Forgivable portion of the Canada Emergency Business Account (CEBA) interest free loan
- Forgivable loan associated with the Canada Emergency Commercial Rent Assistance (CECRA)
- Assistance received through Industrial Research Assistance Program (IRAP) – which may also reduce eligible expenditures for scientific research & development purposes
Positive cash flow within a pandemic is certainly a rare commodity. As such, where a Canadian subsidiary may have positive cash-flow that is required to sustain the operations within a multinational organization, a foreign parent may request an upstream loan from the Canadian subsidiary. This may be in addition to other repatriation mechanisms including royalties, interest, and dividends.
Where an upstream loan is advanced to a foreign parent, or to connected corporations via the foreign parent, the loan must be repaid with one year after the year indebtedness arose, in order to avoid the loan being deemed to be a dividend. Such a result would incur withholding tax.
In addition, from the period the loan arises, prescribed interest rates should apply to the loan to recognize interest income in Canada. Where interest is not charged on the loan, the CRA will deem a prescribed rate of interest to be included in taxable income (currently 1%).
If the loan is required beyond one year, after the year of indebtedness, a pertinent loan or indebtedness election can be made that maintains the form of the loan and prevents the deemed dividend rules. The election does result in a higher rate of interest on the loan (currently 4.27%).
Where funds are received from certain related non-residents in the form of debt, thin-capitalization rules restrict the ability of the Canadian subsidiary to deduct interest expense if the debt exceeds 1.5 times the debtor’s equity. The thin-capitalization rules apply to Canadian branches of foreign corporations, as well.
Interest, on debt that is over the 1.5 ratio to equity, will be non-deductible for Canadian taxable income purposes, and the excess interest will be treated as a dividend for withholding tax purposes.
Both IFRS and US GAAP restrict the ability to carry deferred tax assets where future profitability may be in doubt. Therefore, in 2020, where businesses may incur operational losses, careful consideration will need to be given to whether losses that are not fully utilized in the current taxation period, or previous 3, can be carried forward as a deferred tax asset, or whether a valuation allowance may need to be calculated in its place.
When it comes to COVID-19 relief, a cautious approach should be taken with regards to cost-plus transfer pricing methodologies. The likely CRA policy is that COVID-19 assistance should not reduce costs for transfer-pricing purposes. Under TPM-17, where a Canadian taxpayer receives government assistance and participates in a cross-border controlled transaction (typical with contract R&D and manufacturing), it should not share any part of the assistance with non-arm’s length non-resident persons, and the CRA is indicating that the policy may remain for COVID-19 (wage subsidy) assistance. A reminder that a change to your transfer-pricing transaction flow, by reducing allocable cost or mark-up, should be done within an economic analysis.