Presented by: Faizal Valli CPA, CA (Ernst & Young LLP) Ilia Korkh, JD (Couzin Taylor LLP)

Transcription

1 Presented by: CPA, CA (Ernst & Young LLP), JD (Couzin Taylor LLP) Vancouver Young Practitioners Group October 7, 2015 Outline Digital Economy introduction Incorporation and CCPC considerations Alternative Financing: crowdfunding and Bitcoin Select financing and tax incentives Cross-border: permanent establishment basics High-level US tax considerations Cross-border: WHT and FTC Stock-based incentives and compensation High level international structuring and BEPS 2

2 What is Digital Economy? 3 Key features of digital economy relevant for tax purposes Borderless digital business models. Low start-up costs and high volatility due to disruptive technology allow for fast growth. Mobility of staff and users bring cross-border issues to the forefront. Mobility of IP and business functions means more room for crossborder planning. Multi-sided business models challenge established principles of taxation. Low personnel needs mean higher revenue per employee. 4

3 Sample Company: Two Canadian founders of the website Billables come up with a SaaS B2B offering for law firms to create transparent real time billing and time management interface. They team up with a USbased professional to develop the product. 5 Incorporation considerations Share articles, rights, and restrictions Seed money on incorporation: shares or debt? Shares: PUC averaging risk see ss.89(1) paid-up capital Debt: interest or non-interest bearing? Interest deductibility and para.20(1)(c), paid vs. accrued Non-interest no legal/tax requirement to charge interest Formalize loan in a legal agreement Repayment of seed money Shares deemed dividend on PUC reduction NIL ss.84(2) or (4) Debt repayment of SH loan ABIL: Debt vs. Share para.39(1)(c) and ss.50(1) 6

4 CCPC considerations Benefits of CCPC status Small Business Deduction Refundability of SR&ED tax credits Allowable Business Investment Loss Capital Gains Exemption Structuring dilemma Entrepreneur wants simple and affordable individual owns shares of Opco Advisor suggests optimal and costly Trust owns shares of Opco 7 8 Alternative Financing: Crowdfunding Different models, but two primary types: Rewards Crowdfunding (i.e. product/service or gift) Equity Crowdfunding (issue of shares, available in BC since May) CRA expressed views published in a series of rulings. Initial position (2013) was that all money raised would be taxable under s.9 as voluntary receipts obtained by virtue of carrying on business (as per Folio S3-F9-C1). Later positions are more flexible and consider the nature of the funding on a case by case basis: loan, capital contribution, gift, income, prepayment, or a combination thereof. The default position (in a business context) is taxable income Important question is whether there is a business or not. Reasonable costs related to crowdfunding may be deductible. No comments on equity crowdfunding, but expected.

5 Alternative Financing: Bitcoin Not a common feature of business. But has benefits as efficient, transparent and trustworthy medium of exchange. CRA views published in a series of rulings: Bitcoin is not a real currency for Canadian tax purposes; Bitcoins are treated as a commodity (property). Transactions involving Bitcoins are barter transactions as set out in IT-490. General principles of s.3 and s.9 apply. Income vs. capital treatment on the trade or sale of bitcoins. Mining Bitcoins may be a business, in which case Bitcoins will be held as inventory. The value of inventory must be determined at the end of each year (s.10 ad Part XVIII of the Regs). Need to convert the amount at transaction time to CAD. 9 Financing: BC Venture Capital Credit Type of investment: Venture Capital Corporation (VCC) invests in a number of eligible small businesses Eligible Business Corporation (EBC) registers to accept equity investments from investors Tax credit: Individuals - 30% refundable tax credit on investment up to $200,000 (i.e. credit of up to $60,000) annually Corporations - 30% non-refundable tax credit, no limit Unused credits carry forward four years Other provinces have similar credit (NL 30%, MB 45%, NB, YK, not in ON?) 10

6 BC Venture Capital Credit Programs: Equity Capital, Clean Tech, New Media, Community and Business Creation Apply annually, first come first served basis EBC or VCC issues certificate tax slip SBVC 10 Additional considerations Only available to BC resident individuals/corporations Must hold shares for 5 years, or pay back pro-rata Consider 12(1)(x) Income inclusion, but ss. 53(2.1) election allows ACB reduction (as per para.53(2)(s)), which meets the 12(1)(x)(vii) exception If EBC or VCC share is RRSP eligible, potential RRSP deduction 11 SR&ED Basic research, applied research, experimental development undertaken in Canada by taxpayer or on its behalf Eligible expenditures for ITC include: Salaries and wages Materials consumed or transformed in SR&ED Subcontractors (only 80% of expenditures) Overhead (traditional or proxy 55% of salary base) Capital expenditures no longer eligible Deduct government and non-government assistance (incl. provincial SR&ED ITC s) 12

7 SR&ED ITC s Federal ITC 20% for all claimants (non-refundable, offset against Part I tax payable carryback 3 years and carryforward 20 years), or 35% for CCPC up to $3M Expenditure Limit Refundable for CCPC with income < $500K and taxable capital < $10M (amongst all associated corporations) Provincial ITC 10% BC (refundable and non-refundable) 10% to 20% in other provinces (up to 35% in Quebec) 13 SR&ED ITC example $200,000 SR&ED eligible salaries Nominal overhead, so Proxy Method election $200,000 current expenditures Plus $110,000 prescribed proxy amount (55%) Less BC SR&ED ITC $31,000 ($310,000 x 10%) = $279,000 eligible for Federal refundable ITC $97,650 Federal refundable ($279,000 x 35%) Plus $31,000 BC refundable ($310,000 x 10%) $128,650 refundable ITC If non-ccpc then $72,850 non-refundable ITC 14

8 Paragraph 12(1)(x) General rule: government/non-government assistance is included in income Federal/provincial ITC s included in income if they don t reduce SR&ED Expenditure Pool SR&ED Expenditure Pool Add: Eligible SR&ED expenditures for ITC Deduct: Government and non-government assistance Federal and provincial SR&ED ITC applied/refunded Add back: assistance repayments, ITC recapture Carryforward pool indefinitely 15 BC Interactive Digital Media Tax Credit (IDMTC) Taxable Canadian corporations with PE in BC Principal business of developing digital media products Aim to educate, inform or entertain, and present information in at least 2 of: text, sound or images Common examples: Video games (online, mobile or console) Educational software Simulators Excluded products: Online magazines or newspapers Video streaming applications Social media products 16

9 BC IDMTC > $100,000 of eligible salaries paid to individuals resident in BC Must annually register with BC Finance in advance Cannot claim IDMTC if: Claiming BC SR&ED, registered VCC, etc. IDMTC = 17.5% of eligible salaries minus any assistance received (excluding federal SR&ED) refundable IDMTC claimed included in income per para.12(1)(x) IDMTC should reduce federal SR&ED ITC purposes (Part 4 of T661) Can Billables claim BC IDMTC? See BC Finance website: IDMTC and used interactively 17 IDMTC other provinces Manitoba 40% up to $500,000 credit Ontario 35%-40% Quebec 30%-37.5% New Brunswick - 30% up to $500,000 credit Nova Scotia 25% or 50% PEI 25% Digital Animation or Visual Effects Tax Credits BC, Ontario, Quebec 10%-20% of eligible labour Canada Media Fund IRAP (Government of Canada) - 12(1)(x) income - 20(1)(hh) deduction for repayment 18

10 19 Cross-border: Permanent Establishment Interaction of domestic law and treaties Need liability under domestic law under carrying on business or similar test. Once liability exists, consider treaty protection. Low threshold under domestic law: Common law carrying on business Place of profit producing activity. No need for presence of personnel. Consider place of contract if selling, location of services if providing services. CRA view: location of digital inventory and use of a.ca domain name. Also s.253: solicit orders or offer for sale through an agent or servant Can a server or an ISP be considered agent or servant? Cross-border: Permanent Establishment Art.7 basic principle business profits taxed in the country of residence unless there is a PE under Art.5 If carrying on business under domestic law but protected by Art. 7, still may have compliance and tax filing obligations. Art.5(1) PE: a fixed place of business through which the business of an enterprise is wholly or partly carried on OECD and CRA view: Websites do not trigger a PE. CRA view: IT infrastructure (i.e. host servers, etc.) may trigger a PE where they are (a) owned or leased by the business, (b) at the disposal of the business, and (c) perform core business functions. Consider preparatory or auxiliary carve-out in Art.5(4) Consider active/passive servers. The OECD positions is expected to change following BEPS. 20

11 Cross-border: Permanent Establishment Art. 5(5) PE and 5(6) carve-out. A person acting on behalf of an enterprise and has, AND habitually exercises an authority to conclude contracts in the name of the enterprise Watch out for employees or founders/directors/offices travel. Contracts substantially negotiated overseas but rubberstamped in Canada may be an issue. Similar concerns for automated sales software (i.e. Salesforce.com). No PE where enterprise carries on business through any agent of independent status, provided that such persons are acting in the ordinary course of their business Two part test: (a) independent agency and (b) ordinary course of business. Need to consider both legal and economic independence. 21 Cross-border: US federal income tax Foreign corporation s effectively connected income (ECI) subject to US tax Foreign corporation resident in treaty country subject to US tax based on PE If ECI but no PE: foreign corporation not subject to US income tax, but must file treaty-based return Form 1120-F 22

12 Cross-border: US state income tax State income tax liability determined differently by each state, based on foreign corporation s nexus or connection to a state, such as: soliciting orders storing inventory renting office space Generally, states are not party to US tax treaties and some choose not to follow treaties Foreign corporation may not be subject to US federal income tax, but subject to state income tax 23 Cross-border: US sales tax Similar to Canadian GST/HST and PST No federal sales tax/vat, only states and municipalities Sales in a state of: tangible personal property services intangible property (e.g. software) Wholesale transactions generally exempt US payroll withholdings (income tax, social security and medicare tax, unemployment tax) 24

13 25 Cross-border: Royalties WHT Question of characterisation of income Using Canada as an example (similar rules abroad): General obligation to withhold 25% of royalties paid to nonresidents. Royalty is payment for a right to use copyright or intangible. CRA exception for shrink-wrap computer software which is considered sale of good and payment for such not a royalty. Hallmarks of shrink-wrap : broad standardised EULA, noncustomisable product, with no right to underlying IP and no right to sub-licence. Other jurisdictions have various requirements for this. But income from sale of goods is treaty protected under Art.7. Also carve-out in 212(1)(d)(vi) for copyright in respect of production or reproduction of artistic work. Computer software may be a literary work. Cross-border: Services WHT Question of characterisation of income Many jurisdictions also impose a domestic WHT for payment for provisions of technical services. Need to turn to treaty relief to reduce WHT: May be a standalone service seen as business profits under Art. 7 and fully treaty protected (i.e. 0% WHT) Some treaties expressly include payment for related services in the definition of royalties under Art.12. (10-15% WHT) May be ancillary resulting in implied inclusion as royalties under Art.12 (10-15% WHT) Look at domestic law > Look at Art. 12 for express inclusion > consider whether standalone or ancillary Different WHT rates make bundling of services with licences fees is problematic without express allocation of payments. 26

14 27 Cross-border: FTC Cash tax where company is non-taxable in Canada Companies expect FTC. But FTC is not always available. See Folio S5-F2-C1 and s.126. FTC cannot exceed tax paid in Canada on that income in a year. On a country-by-country basis. Two types of FTC: Business taxes (BT) and non business taxes (NBT). Main difference is that BT may be carried forward 10 yrs. BTFTC is only available where taxpayer carries on business in another country. WHT payment generally quality for NBTFTC. To obtain NBTFTC need (a) income sourced in that country and (b) have paid income or profits tax that is not voluntary or refundable. CRA view that payments made not at an appropriate rate (i.e. in excess of treaty rates) are voluntary. A deduction may be available, although limited (ss. 20(11)(12)). Stock-based compensation Business reasons to issue shares Preferred method for cash-strapped business Employees/officers with ownership stake will have greater commitment to company Attract and retain talent Shares issued to contractors Report FMV of shares received as income No further benefits afforded 28

15 Stock-based compensation CCPC Issued to employees, officers and directors S. 7 - corporation has agreed to sell or issue shares At grant date Shares 7(1)(a) employment benefit = FMV of shares issued amt pd Options No tax implication if FMV = option exercise price At exercise date N/A 7(1)(a) employment benefit = FMV of shares purchased exercise price 7(1.1) employment benefit deferral? Yes, to disposition / exchange date 110(1)(d.1) ½ dedn? Yes Yes Yes, to disposition / exchange date 29 Shares Options CGD Dilution Cash outlay 2 year hold test starts at date shares received Company can issue less shares Employees need not pay for shares 2 year hold starts at date options exercised Company typically issues more options Employees must pay for shares Vesting period Can issue immediately Can issue over specified vesting period 30

16 High Level Cross-Border Considerations Taking advantage of the high mobility of business functions and value assets to achieve optimal tax results. Classic Approach: IP off-shoring to low tax or tech-box jurisdictions Base erosion and profit shifting in high tax jurisdictions Artificial avoidance of PE status in market jurisdictions: agent/commissionaire; auxiliary status of activities. Fragmentation of different sides of same business. BEPS Action 1 Report: Addressing the Tax Challenges of the Digital Economy Final report on October Updated PE exceptions, attribution of value to data (transfer pricing), and digital economy specific CFC rules. Expected updates to PE provisions in treaties and commentary. IP on-shoring 31