Written by Anu Nijhawan, Claire Kennedy and Philip Ward
The COVID-19 pandemic has resulted in the imposition of travel restrictions by governments and businesses. While such restrictions are no doubt valuable in "flattening the curve", they do, amongst other things, pose challenges to Canadian multinational groups in maintaining the "mind and management" of foreign subsidiaries in the appropriate non-Canadian jurisdictions. The Canada Revenue Agency (CRA) has recently released helpful, although not definitive, guidance on certain tax residency issues resulting from such travel restrictions, which is generally consistent with guidance provided by other tax authorities worldwide. The CRA guidance does not, however, explicitly address the analysis of corporate residency as it applies to the exempt surplus mechanism in Canada's foreign affiliate regime. As such, uncertainty remains. There are, however, various risk-mitigation strategies that Canadian multi-national groups with foreign affiliates can consider in these extraordinary circumstances.
The Concern: Importance of Mind and Management within the Foreign Affiliate Regime
Although highly complex in its details, the Canadian foreign affiliate regime is straightforward in its structural framework. Dividends received by a Canadian corporate shareholder from a foreign affiliate are generally either exempt from Canadian tax or eligible for deductions in respect of foreign taxes, depending on whether the income is sourced from active business or passive earnings of the foreign affiliate and on whether or not Canada has a bilateral tax treaty with the jurisdiction to which the income is attributable. Of particular import for the purposes of this blog, dividends paid from the active business income of a foreign affiliate are generally received free of Canadian tax as "exempt surplus" dividends, provided that the foreign affiliate is resident in a treaty country—both under the common law principle of central management and control (common law residency) and as defined in the applicable treaty (treaty residency). Generally, a foreign affiliate can establish treaty residency by virtue of being incorporated in the foreign jurisdiction, but common law residency requires more care and attention. Canadian tax treaties often contain a "tie-breaker rule" to determine residency—such as place of incorporation, which is used in the Canada-US treaty—and consequently the treaty residency of foreign affiliates may not be affected regardless of where mind and management abides. These treaty tie-breaker rules do not, however, apply for the purposes of common law residency, which as noted above must also be maintained in order for dividends to qualify as tax-free exempt surplus dividends under the foreign affiliate regime.
Under the common law residency test, a corporation is resident in the jurisdiction in which its central management and control, or "mind and management", abides. Although the determination of mind and management is heavily fact dependent and will depend on all the relevant facts and circumstances, the critical element is that mind and management generally exists where the corporation's board of directors exercises its responsibilities. As such, the jurisdictions where directors' meetings are held and where directors exercise their strategic and management responsibilities in respect of the corporation are factors of particular importance. Accordingly, care is typically taken to ensure that:
- the majority of directors of a foreign affiliate reside in the desired jurisdiction;
- such local directors are suitably qualified and empowered to make appropriate business decisions on behalf of the corporation; and
- the board of the corporation exercises its decision-making function at meetings physically held in the appropriate jurisdiction with any Canadian-resident directors travelling to be in attendance.
These best practices may not, however, currently be possible in the face of the various COVID-19 related travel restrictions. Boards may be forced in these extraordinary conditions to abandon their regular practice of in-person meetings in a specific jurisdiction in favour of electronic or telephone meetings, with some directors participating from Canada or other jurisdictions. Alternatively, boards may be viewed as having ceased to exercise central management and control functions where key decisions are made by individuals acting from Canada in the absence of board meetings. The concern in such circumstances is whether the foreign affiliate's mind and management may be considered, as a result of these conditions, to be exercised otherwise than in the specified treaty jurisdiction, thereby risking the exempt surplus tax treatment of dividends paid by the foreign affiliate.
While we discuss here steps to be taken by non-Canadian corporations which wish to ensure they retain residency in the appropriate treaty jurisdiction for the purposes of Canada's foreign affiliate tax regime, similar issues will apply to corporations that wish to sustain their intended corporate residency in Canada or another jurisdiction if directors are unable to travel to meetings.
CRA and Other Tax Authority Guidance
On May 20, 2020, the CRA released guidance on certain potential international tax issues arising from the COVID-19 pandemic, including the residency of non-Canadian corporations. Such guidance is initially applicable from March 16 to June 29, 2020, at which time the CRA will determine if an extension of the applicability period is warranted. In response to the question of whether the Agency would consider a corporation's central management and control to be in Canada if the directors of such corporation participate in board meetings while in Canada, the CRA responded as follows:
- Where the corporation is subject to a tax treaty which contains a corporate residency tie-breaker rule determining that a corporation is resident in the country under whose laws it was created, those rules will generally address the residency issues;
- Where the corporation is subject to a tax treaty which contains a corporate residency tie-breaker rule that looks to the corporation's place of effective management, the CRA will not consider the corporation to become resident in Canada solely because directors participate in a board meeting from Canada due to travel restrictions resulting from COVID-19; and
- Where the corporation is not subject to a tax treaty, determinations of corporate residency will be made on a case-by-case basis.
The CRA's guidance is consistent with that offered by the Organisation for Economic Co-operation and Development, which, while not commenting on individual countries' domestic law, has stated that the extraordinary and temporary disruptions caused by COVID-19 should not affect the residency of companies under international tax treaty rules, particularly in light of treaty tie-breaker rules which focus on the ordinary and usual place of effective management.
Notably, however, the CRA guidance does not deal with corporate residency determinations within the foreign affiliate regime; it follows that such determinations will be made on a case-by-case basis. That notwithstanding, the CRA guidance does indicate that the extraordinary circumstances of the COVID-19 pandemic should be taken into account in corporate residency determinations, and signals an intention by the Agency to act pragmatically in dealing with these unprecedented circumstances.
Helpful guidance can also be gleaned from the positions taken by other international tax authorities, particularly to the extent that such jurisdictions base corporate residency on central management and control. For example, similar to the approach taken by the CRA, UK Inland Revenue has also released guidance that is sympathetic in tone to the disruption faced by taxpayers, which emphasizes the flexibility of the existing law and notes that the US tax authorities "do not consider that a company will necessarily become resident in the UK because a few board meetings are held [in the UK] or because some decisions are taken in the UK over a short period of time". The UK tax authorities have, however, stopped short of issuing a blanket concession or other definitive guidance, preferring to rely on the flexibility of existing law and guidance.
The approach of the Australian Taxation Office is also noteworthy. Pursuant to its recently published guidance, if the only reason for holding board meetings in Australia, or directors attending board meetings from Australia, is because of the impact of COVID-19, then the Australian tax authorities will not apply compliance resources to determine if the corporation's central management and control is in Australia. This offers some practical guidance—where the only reason that a foreign affiliate's directors participate in a board meeting while in Canada is due to COVID-19 travel restrictions, it may be that the CRA will not, from a practical perspective, pursue the matter, although the CRA has stopped short of providing such comfort.
Mitigating the Concern
In applying the common law concept of mind and management, it is important that the pattern of decision-making over the life of the corporation evidence that decisions are made in the appropriate foreign jurisdiction. While the issue of where mind and management is exercised will in each case depend on the particular facts and circumstances, the risks are likely to be exacerbated the longer the COVID-19 pandemic continues to disrupt ordinary practices.
There are, however, several measures that foreign affiliates, and their Canadian shareholders, could consider to mitigate these risks. For example:
- Defer board meetings or major strategic decisions: To the extent practicable, foreign affiliates may wish to defer board meetings until normal practices can resume. This may not be possible in many circumstances due to commercial or regulatory reasons, particularly when it is not clear how long the current restrictions will last, but it may be workable where the planned board meetings are to cover routine business. Even if a meeting cannot be deferred, it may be possible to defer major strategic decisions to later meetings which can occur in person.
- Ensure voting majority of board participates from the appropriate jurisdiction: Multinational groups should carefully consider any available safeguards to ensure that, notwithstanding the travel restrictions, key decisions are taken by a majority of board members who are physically present in the appropriate jurisdiction. For example, foreign affiliates may wish to consider changing the composition of the board, such as through the appointment of additional directors resident in the appropriate jurisdiction. If suitably qualified local candidates are not available, consideration could also be given to changes in voting arrangements such that individuals in Canada participate in board meetings but only as non-voting observers. Decision-making powers could also be delegated by Canadian directors to local directors. The risk of an adverse residency determination will clearly be lower where Canadian-based directors are a minority and their influence is not disproportionate to that of other directors. Whether any of these measures is possible in any particular case will depend on the governing corporate law and constating documents of the particular foreign affiliate, and consideration may need to be given to amendments to constating documents.
- Assess influence of Canadian directors: Where Canadian directors do participate in a board meeting electronically or by telephone, their expertise and influence relative to the local directors should be evaluated and care taken to ensure that decisions are, and are seen to be, taken by a majority of the board not including the Canadians. To the extent possible, corporations may want to ensure that the chair of the meeting is a non-Canadian and that quorum requirements are satisfied independent of the attendance of any Canadian residents. Consideration could also be given to having directors present in Canada abstain from voting on material decisions taken at a board meeting, provided the relevant corporate law and the corporation's constating documents permit such an approach.
- Manage and record video/teleconference participation: If directors in Canada participate in board meetings by way of video or teleconference, their participation by such means should be recorded, and any video or teleconference should, to the extent possible, be initiated and hosted by participants in the foreign jurisdiction. Such evidence will be useful if there is ever an inquiry into corporate residency. It is also worth noting that the constating documents of some foreign affiliates may dictate requirements for board meetings which may be rather inflexible, such as requiring all board meetings to be held in person outside of Canada. If a corporation's constating documents do contain such restrictions, it may be necessary to evaluate whether amendments should be made.
- Document extraordinary circumstances: We would recommend that foreign affiliates clearly document the COVID-related disruptions. For example, recording in meeting minutes that board members were not permitted to travel and hence are participating via teleconference may assist in establishing the extraordinary and temporary nature of the departure from normal practice.
The location of the central management and control of a non-Canadian corporation is determined on a case-by-case basis taking into account the corporation's facts and circumstances over a period of time. As such, we would not expect that temporary changes in practice should generally cause a shift of residency, but that position is uncertain as the COVID-19 related travel restrictions continue. The suitability of, and need for, any of the above-noted measures will doubtless vary according to circumstances, but foreign affiliates should remain mindful of the importance of maintaining mind and management in the appropriate jurisdiction outside of Canada in these challenging times. In all cases, Canadian multinational groups should consider their next steps with their advisors to help solve for potential tax residency issues.
The Bennett Jones Tax and Public Policy groups continue to work with employers, government and other national and local organizations to work through these issues, and would be pleased to assist you as you look to identify and implement strategies in connection with these or similar issues. In addition, please visit our COVID-19 Resource Centre for other COVID-19-related materials.